INVESTMENT  BONDS 

THEIR  ISSUE  AND  THEIR  PLACE  IN  FINANCE 

A  BOOK  FOR  STUDENTS,  INVESTORS,  AND 
PRACTICAL  FINANCIERS 


BY 

FREDERICK  LOWNHAUPT 


G.  P.  PUTNAM'S  SONS 

NEW  YORK  AND  LONDON 
•Knickerbocker   press 
1908 


COPYRIGHT,  1908 

BY 
FREDERICK  LOWNHAUPT 


Ube  fmicfcerbocfeer  press,  flew  |?orft 


PREFACE. 

SOME  months  past  a  prominent  banker  of  this  city 
delivered  an  address  touching  largely  on  Investment 
Bonds,  in  the  course  of  which  he  was  requested  to 
mention  a  work  devoted  entirely  to  that  subject.  The 
reply  was  that  he  knew  of  no  book  of  this  nature  and 
he  believed  that  none  existed;  and  a  review  of  current 
financial  literature  confirmed  this  belief.  That  inci- 
dent, together  with  numerous  similar  inquiries  that 
have  come  to  the  attention  of  the  author,  is  responsible 
for  the  present  volume. 

Nearly  every  other  branch  of  finance  has  received  an 
adequate  measure  of  attention.  There  are  for  instance, 
fully  a  score  of  good  works  on  the  various  aspects  of 
banking  and  on  kindred  subjects.  It  is  a  singular 
fact,  however,  that  Investment  Bonds,  taken  as  a 
separate  subject,  have  had  scant  consideration.  The 
published  information  at  present  available  on  the 
subject  is  scarcely  more  than  passing  mention  in  some 
financial  works,  one  or  two  small  volumes  which  are 
little  else  than  reference  works,  and  the  advertising 
pamphlets  of  banking  houses.  This  material  is  so 
scattered  as  to  preclude  the  possibility  of  obtaining 
from  it  any  satisfactory  amount  of  trustworthy  in- 
formation. Only  a  few,  comparatively,  such  as  those 
whose  daily  association  with  this  branch  of  finance 
affords  them  opportunity  for  its  study,  are  in  a  position 
to  learn  of  its  many  phases. 

There  is  indeed  a  highly  technical  side  to  the  sub- 
ject, especially  in  the  mathematics  involved,  yet  there 

iii 


iv  Preface 

are  many  plain  facts  fundamental  to  an  understanding 
of  the  matter  that  may  be  expressed  in  untechnical 
language  and  readily  understood. 

It  is  essential  to  any  one  concerned,  whether  as  a 
student  in  the  investigation  of  financial  science,  as  an 
investor  in  the  determination  of  the  value  of  a  security 
as  an  investment,  or  as  an  employee  in  an  endeavor 
to  become  equipped  for  greater  efficiency,  that  these 
facts  be  known. 

The  contents  of  this  book  have  been  developed 
with  reference  to  two  principal  ideas,  that  of  the  rela- 
tion of  the  bond  to  its  issuing  corporation,  and  the 
general  investment  aspect  of  the  instrument.  These 
central  ideas  have  been  developed  to  treat  of  classifica- 
tion of  issuing  corporations  and  specific  issues;  process 
of  issue  and  the  practices  of  negotiation ;  market,  in  its 
extent  and  general  conditions;  interest,  in  its  defini- 
tion, methods,  and  times  of  payment;  security,  in  its 
relationship  to  various  types;  default  and  its  effects; 
reorganization  and  how  accomplished,  etc.,  together 
with  other  important  features. 

Obviously,  it  is  difficult  to  treat  comprehensively 
such  a  broad  subject  within  so  limited  a  space;  and  it 
is  equally  difficult  to  arrange  the  vast  amount  of 
material  to  the  best  advantage. 

It  is  the  hope  of  the  author,  however,  that  this 
volume  will,  in  a  measure,  fill  a  recognized  need. 

Acknowledgment  is  hereby  made  of  the  assistance 
received  from  friends  by  criticism  and  suggestion,  and 
to  the  investment  house  of  H.  H.  Copeland  &  Son  for 
access  to  their  files,  documents,  statistics,  etc. 

F.  L. 

NEW  YORK  CITY. 
September  i,  1908. 


CONTENTS 

CHAPTER  PAGB 

I.  INTRODUCTORY.  The  financial  instrument  known 
as  a  bond  distinguished  from  other  instru- 
ments of  the  same  name — Distinguished  from 
other  instruments  such  as  stock — Its  origin 
and  development — Peculiarly  a  corporation 
instrument — Characteristics,  legal  and  financial 
— Status  of  bondholder — General  purposes  and 
expediency  of  bond  issue — Comparison  of  size  of 
issues  and  aggregate  amounts  of  bonds  and  stock 
— General  uniformity  from  whatever  source 
issues  are  made  .....  1-13 

II.  CLASSIFICATION.  Various — General  divisions  of 
issuing  corporations  and  their  nature — Specific 
corporations  of  each  division — Types  of  bonds 
issued  by  each  corporation  and  their  definition 
— Relation  of  name  and  nature  of  bond — Com- 
binations of  names — Charted  classifications  14—35 

III.  DENOMINATIONS.     Wide  range — Round  sum  gener- 

ally— Exceptions — One-thousand-dollar  bond 
the  standard  in  the  United  States — Other 
standards — Denominations  affected  by  statu- 
tory provisions  and  other  conditions — Extent  to 
which  they  affect  the  marketability  of  an  issue  36-42 

IV.  PROCESSES  OF  ISSUE  AND  NEGOTIATION.     Authori- 

zation— Approval — Reporting — Certification  of 
genuineness  and  delivery — Transferral  to 
bankers,  public  or  others,  by  private  or  public 
sale — Underwriting  by  syndicate — Syndicate 
formation,  operation,  management,  etc. — 
Underwriting  absolute  or  conditional — Market- 
ing to  bond  houses,  banks,  etc. — Organization 
and  operation  of  bond  houses — Issues  passing 
from  bond  houses  and  banks  to  sub-dealers, 


vi  Contents 


CHAPTER  PAGF 

brokers,  etc. — Dealings  on  the  curb  and  Stock 
Exchange  and  by  bond  arbitrageurs — Rules 
governing  transactions  on  the  Stock  Exchange 
— Practices  of  negotiation  ....  43-60 

V.  LIMITATIONS.  As  to  amount  of  issue — As  to 
amounts  for  delivery  after  certification — Muni- 
cipal limitations  statutory  or  constitutional — 
Their  removal  and  exceptions  to — Limitations 
as  to  rate  of  interest — As  to  per  mile  amounts — 
As  to  application  of  proceeds  of  issue — As  to 
selling  price — As  to  maturity — As  to  form  .  61-65 

VI.  LEGALITY.  Is  an  important  consideration — Points 
involved — Certification  of  legality,  by  whom, 
method  of — Distinct  from  certification  of  gen- 
uineness— Certification  a  universal  practice — 
What  it  accomplishes  for  the  bond — Causes 
and  effects  of  illegality  ....  66-71 

VII.  MARKET.  Extent  to  which  it  affects  the  time  of 
issue — Special  times  of  demand,  such  as  interest 
periods — General  conditions  affecting  the  mar- 
ket, such  as  money  market,  confidence,  class  in 
which  the  issuing  corporation  is,  etc. — Special 
conditions  affecting  the  market,  such  as  corpo- 
rate conditions,  degree  of  security  for  the  issue, 
Stock  Exchange  listing,  etc. — Sectional  charac- 
teristics— Home  and  foreign  markets  .  .  72-90 

VIII.  HOLDINGS.  Corporate  holdings  and  their  relation 
to  total  output — Consideration  of  the  principal 
corporations  holding  bonds  such  as  Life  Insur- 
ance Companies,  Savings  Banks,  Commercial 
Banks,  Trust  Companies,  etc. — Approximate 
amounts  owned  by  each — Corporations'  hold- 
ings of  their  own  bonds  as  investments  for  their 
Sinking  Funds — Individual  and  private  hold- 
ings— Factors  influencing  special  holdings,  such 
as  foreign  population,  State  and  Federal  laws, 
geographical  position  of  investor — Reporting 
of  holdings  by  corporations  and  its  object  .  01-99 

IX.  INTEREST.  What  it  is  as  distinguished  from  divi- 
dend— Differentiated  from  yield  or  return — 


Contents  vii 


Kinds — Approximate  amounts  of  interest  on 
interest-bearing  bonded  debts  of  various  classes 
of  corporations — Position  of  interest  charges 
in  the  finances  of  a  corporation — Methods  and 
periods  of  payment — Average  rate  of  interest 
on  various  classes  of  bonds — External,  internal, 
special,  and  general  conditions  affecting — 
Sources  of  funds  to  pay  interest — Effect  of  in- 
terest charges  of  a  company  on  its  stock  .  100-109 

X.  SECURITY.  Most  important  consideration,  it  being 
the  basis  of  value  of  a  bond — Physical  and  ap- 
parent security  is  property,  real  and  personal, 
under  lien  and  consists  of  real  estate,  road  bed, 
equipment,  other  securities,  etc. — Sometimes 
both  real  and  personal  for  same  issue — Actual  or 
real  security  is  lien  on  income,  solidarity  of 
corporation,  relative  position  to  other  issues, 
integrity  of  management,  etc. — Indications  as 
to  strength  of  security,  such  as  discrimination 
of  laws,  market  quotations,  value  as  collateral, 
etc. — Relation  of  security  to  premium,  interest, 
etc.  .......  110—124 

XI.  GUARANTEE.  Distinction  to  be  made  between 
guarantee  and  certification — Distinction  to 
be  made  between  an  assumed  bond  and  guar- 
anteed bond — Guarantor  is  generally  a  parent 
company;  may  be  a  number  of  companies 
making  joint  guarantee — Authorization  of — 
Form  of  guarantee  and  variations  thereof — 
Method  pursued  in  guaranteeing  bonds — Causes 
and  effect  of  guarantee — Status  of  guaranteed 
bonds  .......  125—132 

XII.  MATURITY.  Definition  of  the  term — Time  varies — 
May  be  contingent  by  bonds  being  subject  to 
redemption  by  call — Explanation  of  process  and 
variations  of  practice  in  redemption — Maturity 
may  be  indeterminate  by  optional  privilege  of 
exchange  for  other  securities — May  be  actually 
extended  by  agreement — Some  debts  actually 
perpetual  while  many  are  virtually  so — Payment 
of  bond  at  expiration  rare — The  comparatively 


viii  Contents 


new  process  of  serial  maturity — Factors  affect- 
ing maturity — Effects  of  it  on  market,  etc.  133-139 

XIII.  MORTGAGE.     What  it  is  from  a  legal  standpoint — 

Some  general  provisions  of  law  affecting  same — 
Process  of  making  by  counsel — Execution  of, 
by  proper  persons — Place  of  recording — Deposit- 
ing with  trustee — General  analysis  showing  its 
main  provisions — Similarity  of  mortgages  as  to 
form — Supplemental  indentures,  their  form  and 
object — May  be  co-existent  mortgages  on  one 
property — Mortgage  may  be  closed  absolutely ; 
may  be  open  absolutely  in  a  sense — Conditions 
such  as  permission  for  annual  issue  of  a  speci- 
fied amount  only,  syndicate  permission  to  issue 
further,  etc.,  which  make  it  neither  open  nor 
closed — Purpose  and  desirability  of  closed  mort- 
gage— Ineffectiveness  of  closed  generally — Gen- 
eral practice — Some  effects  pfoduced  by  either 
kind  .......  140—152 

XIV.  LEASE.     Its  nature — Multitudinous  variety  running 

from  few  years  to  perpetuity — Some  general 
purposes  in  its  use — Extent  of  its  use  and  its  re- 
lation to  the  gradual  consolidation  going  on — 
Some  methods  of  payment  for  corporate  lease 
— Effects  of  lease  as  regards  bonds  of  lessor  or 
lessee  .......  153—159 

XV.  TAXATION.  Nature  of  same — Levied  by  statute — 
Authorities  levying  same  and  course  pursued 
in  collection — Tax  collectible  on  par  value  of 
securities — Object  of  taxation  revenue  purposes 
— Effects  of  it  on  market — Some  bonds  abso- 
lutely exempt — Some  wholly  or  partially  to  in- 
vestor only  ......  160-165 

XVI.  REFUNDING.  Growing  and  universal  practice — 
Explanation  of  its  authorization  and  processes 
employed  by  governments  and  other  corpora- 
tions— Some  objects  in  the  use  of  it  for  various 
corporations — Affects  the  interest  charges  to 
be  met — Perpetuates  the  debt — Often  brings 
property  under  one  mortgage — Provisions 
against  it  sometimes  necessary  .  .  166-174 


Contents  ix 


CHAPTER  PACK 

XVII.  EXCHANGE.  Conditions  which  bring  about  ex- 
change of  bonds  of  one  issue  for  those  of  another, 
such  as  reorganization,  desire  to  unify  debt  into 
one  issue  of  bonds,  organization  of  a  trust,  etc. — 
The  method  of  procedure  usually  followed — 
Results  and  advantages  therefrom — Exchange 
of  bonds  for  stock  a  widespread  practice — 
Explanation  of  the  operation — Effects  of  same — 
Stock  for  bonds  a  rare  occurrence  .  .  175-184 

XVIII.  BONDS  AS  COLLATERAL.  Held  as  such  by  practically 
every  large  financial  institution  loaning  money, 
by  banks,  bankers,  insurance  companies,  etc.; 
for  notes  of  individuals  and  corporations  and 
on  plain  collateral  loans;  by  Government  for 
public  deposits  and  bank  circulation — Methods 
pursued  in  placing  bonds  as  collateral — Gener- 
ally are  only  a  portion  of  total  amount  deposited 
for  loans — Nature  of  loan  affects  the  percentage 
so  deposited — Influences  determining  the  value 
of  bonds  as  collateral — Substitution  of  securities 
in  loans  ......  185-191 

XIX.  DEFAULT  AND  REPUDIATION.  The  general  extent 
to  which  this  has  occurred  in  various  classes  of 
corporations — The  general  extent  to  which  it 
has  occurred  as  to  principal  or  interest — Some 
conditions  which  have  led  to  it,  such  as  over- 
capitalization, depressions,  etc. — Course  of 
action  by  bondholders  when  this  occurs — The 
extent  of  remedial  measures  possible  dependent 
upon  class  of  corporation  defaulting — Effects 
of  it  on  company's  securities  and  credit — A 
certain  loss  in  some  measure  to  bondholders  192-200 

XX.  REORGANIZATION.  Extent  in  past  and  present — 
Corporate  growth  and  strength  eliminating  its 
necessity  greatly — Various  causes  which  have 
brought  it  about — Action  taken  by  bondholders 
in  forming  committee — Preparation  of  a  new 
plan — General  practices  in  putting  plan  into 
execution — Extent  of  stockholders'  participa- 
tion in  reorganization  scheme  .  .  201-210 


x  Contents 

CHAPTER  TAGS 

XXI.  VOTING  POWER.  Generally  not  accorded  to  bond- 
holders and  reasons  for  this — Names  of  some 
bonds  which  are  exceptions  to  this  general  rule 
— Questions  of  policy  involved  in  allowing  bond- 
holders to  vote — Similarity  between  voting 
bonds  and  preferred  stock  as  to  position — 
Effect  privilege  to  vote  has  upon  the  marketing 
of  an  issue  ......  211-214 

XXII.  MUNICIPAL  BONDS.  Represent  the  great  bulk  of 
public  debt — Some  sections  of  the  country  con- 
servative, some  extravagant,  in  their  issue  of 
bonds — Authorities  differ  as  to  what  constitutes 
public  debt — Direct  and  contingent  municipal 
debts — Municipal  debt  based  on  property  valu- 
ation— Diverse  methods  and  times  of  computa- 
tion of  property  value — Some  special  bonds 
peculiar  to  municipalities  .  .  .  215-224 

XXIII.  SINKING  FUND.     Nature  of  the  fund — Its  use  uni- 

versal by  some  classes  of  corporations ;  its  entire 
absence  in  others — Becoming  less  used  gener- 
ally— Its  use  mandatory,  optional,  or  necessary 
according  to  corporation — How  derived  gener- 
ally— Some  special  conditions  making  it  a 
conditional  operation — Methods  employed  in 
handling  the  fund — By  whom  held — Various 
applications  made  of  it  in  provision  for  payment 
of  debt  or  otherwise — Theoretical  advantages 
of  its  use — Objections  and  failure  of  it  in 
practice  .  225-237 

XXIV.  SERIAL  BONDS.     Distinction  between  bonds  in  series 

and  serial  bonds — Kinds  generally  issued  as  seri- 
als— Methods  of  naming  them — Origin,  develop- 
ment, and  extent  of  the  practice — Differences 
in  process  of  issue  of  these  bonds  as  compared 
with  an  issue  in  its  entirety — Advantages  and 
disadvantages  in  this  form  of  bond  from  various 
view-points  ......  238-244 

XXV.  BALANCE  SHEET.  Corporations  that  make  same — 
Reasons  for  making — Its  nature — What  items 
it  contains — Various  methods  of  their  arrange- 
ment— The  importance  of  its  consideration  in 
judging  the  safety  of  a  bond  .  .  .  245-249 

INDEX 251 


INVESTMENT  BONDS 


CHAPTER  I. 

INTRODUCTORY. 

THE  complexity  of.  modern  business,  its  high  speciali- 
zation, and  broad  ramifications,  necessitate  the  use  of. 
many  instruments.  Indeed  they  have  become  so 
numerous  that  it  is  the  expert  alone  who  can  make 
needful  distinctions  without  difficulty.  Quite  natu- 
rally, the  opposite  is  true  of.  thousands  moving  in  a 
limited  sphere  of.  business  activity,  and  of.  yet  a  greater 
host  removed  from  those  associations  wrhere  many  of 
these  instruments  are  met.  There  is  considerable  per- 
plexity arising  from  numbers  alone;  and  yet  the  diffi- 
culty of  making  proper  distinctions  is  increased  by 
similarity  of  names.  Any  attempt  at  classification  is 
sure  to  be  more  or  less  an  enumeration.  We  have 
those  differing  widely  in  nature  and  functions,  of 
entirely  different  classes,  each  issued  in  a  distinctive 
manner,  and  yet  serving  the  ends  of  business  under 
names  similar  or  identical.  Most  prominent  of  these 
are  bonds,  about  which,  perhaps,  most  confusion  arises. 

Alone,  the  term  bond  has  more  of  legal  significance 
than  otherwise.  In  a  correlative  position  it  becomes 
more  definite  in  application,  and  in  a  measure  classi- 
x  i 


2  Investment  Bonds 

fies,  yet  does  not  assign  the  particular  instrument  to 
a  place  where  its  nature  and  functions  are  clearly 
indicated.  Most  important,  from  its  functions,  and 
most  widely  known,  yet  none  too  well  understood,  is 
the  financial  and  investment  instrument  of  this  name. 
Its  distinction  from  other  so-called  bonds  should  be 
fully  comprehended. 

The  majority  of  real  estate  transactions  are  carried 
out  through  the  use  of  a  bond  and  an  accompanying 
mortgage  especially  adapted  to  requirements.  A  uni- 
versal use  of  this  form  of  bond  gives  it  a  position  of 
great  importance  in  the  business  world  and  makes  a 
comparison  with  the  investment  instrument,  the  prin- 
cipal subject  of  our  discussion,  imperative.  Points  of 
similarity  in  principle  exist,  although  the  instruments 
are  essentially  unlike  in  character.  Both  are,  of 
course,  investment  instruments;  the  one  always,  the 
other  frequently,  being  accompanied  by  a  mortgage. 
The  real  estate  bond  and  mortgage,  as  here  considered, 
are  always  kept  together,  as  if  but  parts  of  one  instru- 
ment; the  investment  bond  and  its  possible  accom- 
panying mortgage  never.  The  bond  of  the  first  instance 
is  practically  an  indivisible  instrument,  covering  the 
full  amount  of  the  debt;  the  investment  bond  is,  in 
itself,  the  representation  of  but  a  portion  of  the  debt. 
Large  debts  of  the  former  type  are  contracted,  how- 
ever,— so  large,  in  fact,  as  to  be  impracticable  for  a 
single  investment;  and  by  issuing  parti-mortgage  re- 
ceipts, an  indirect  method  of  accomplishing  the  end,  a 
divided  interest  may  be  made. 

In  form  this  type  of  bond  is  generally  unlike  the 
investment  bond  in  that  it  may  be  anything  from  an 
ordinary  promissory  note  to  a  highly  engraved  certifi- 
cate with  a  fuller  phraseology.  A  printed  blank,  to 


Introductory  3 

be  filled  up  as  circumstances  require,  is  in  very  general 
use.  Again,  the  bulk  of  investment  bonds  gravitate 
toward  financial  centres  where  they  go  to  investors 
through  a  great  public  market,  whereas,  with  the 
former,  private  sale  predominates. 

The  great  business  of  suretyship  creates  a  still 
different  and  peculiar  class  of  instruments  of  this 
name  which  do  not  represent  an  investment.  The 
surety  bond  is  a  document  binding  one,  called  the 
principal,  for  and  with  another  who  is  primarily 
liable ;  it  is  the  obligation  of  one  who  engages  to  answer 
for  another's  appearance  in  court,  payment  of  a  debt, 
performance  of  an  act,  fidelity  in  a  position  of  trust, 
etc.  While  this  class  of  bonds  is  issued  in  almost 
infinite  variety,  covering  every  conceivable  position 
of  trust,  and  entering  into  many  other  business  trans- 
actions, it  may  be  said  to  consist,  generally,  of  Pro- 
bate, Insolvency,  Judicial,  and  Fidelity  bonds,  the 
larger  part  of  which  business  is  done  by  a  compara- 
tively small  number  of  surety  companies,  corporate 
suretyship  being  most  acceptable. 

As  to  distinctions  between  investment  bonds  and 
various  other  instruments,  principally  certificates  of 
stock  and  various  kinds  of  notes,  it  is  well  to  note  a 
few  facts.  Stock  of  a  corporation  represents  proprie- 
torship, the  total  amount  being  the  full  capital  invest- 
ment by  the  stockholders  in  the  enterprise.  For 
convenience  and  mobility  it  is  divided,  the  standard 
unit  being  $100  which  is  represented  by  a  stock 
certificate.  The  term  share  is  frequently  used  to  ex- 
press the  same  thing.  A  stockholder's  relation  to  his 
corporation  is  that  of  ownership,  having  an  interest 
of  this  nature  to  the  extent  of  his  holdings.  He  par- 
ticipates in  the  management  to  the  extent  of  directing 


4  Investment  Bonds 

the  policy  by  his  vote,  but  has  no  direct  voice  in 
an  administrative  capacity.  Corporate  stock  may  be 
divided  into  two  general  classes,  preferred  and  common. 
As  indicated  by  its  name,  the  former  has  preference  in 
the  distribution  of  profits  or  in  other  ways,  while  the 
common  is  junior  in  any  claims  to  which  the  former 
has  been  given  preference.  Where  there  are  no  out- 
standing bonds  of  a  corporation,  yet  preferred  shares, 
their  preferment  places  them  in  practically  the  same 
relative  position  as  an  issue  of  bonds  would  be. 

Notes,  of  which  there  is  a  great  variety  as  to  form 
and  text,  differ  essentially  from  bonds  in  the  length  of 
time  of  the  debt.  They  may  run  from  periods  of 
thirty  days  to  as  long  as  five  years;  general  practice, 
however,  makes  them  for  two  years  or  less.  In  some 
particulars,  notes  of  corporations  for  large  amounts 
are  very  similar  to  some  kinds  of  bonds,  frequently 
having  like  names,  such  as  debenture  notes  and  col- 
lateral notes.  Considering  the  element  of  time,  many, 
to  all  practical  intents,  may  properly  be  called  short 
term  bonds.  In  amount  they  range  from  the  small 
individual  note  of  perhaps  a  few  dollars  to  the  large 
paper  of  the  great  corporations  which  is  often  in  units 
of  $100,000.  Obviously,  only  investors  of  large  re- 
sources furnish  the  market  for  these  latter;  the  large 
financial  houses  generally  absorbing  all  such  issues. 
In  fact,  the  principal  market  for  all  kinds  of  notes  are 
the  commercial  banks  and  kindred  institutions.  A 
corporation  having  outstanding  such  an  issue  is  said 
'  to  have  floating  debt;  a  debt  contracted  under  bond 
issue  is  funded. 

While  any  instrument  representing  a  debt  may 
properly  be  called  a  certificate  of  indebtedness,  there 
has  come  into  comparatively  recent  use  by  some  rail- 


Introductory  5 

roads,  a  special  instrument  so  called.  To  distinguish 
it  from  a  bond  is  to  say,  generally  speaking,  it  is  neither 
stock  nor  bond,  yet  has  some  of  the  characteristics  of 
either.  Taking  a  representative  issue  as  an  example — 
Atlantic  Coast  Line— it  has,  like  most  bonds,  special 
security,  and  like  stock,  voting  power.  Practically  it 
is  a  combination  of  the  features  of  stock  and  some 
bonds  and  may  be  said  to  represent  no  new  idea  or 
involve  any  special  principle  of  financing. 

As  it  is  to-day,  the  investment  bond  is  somewhat 
the  product  of  evolution,  not  so  much  in  language  of 
text  as  in  physical  features.  The  principle  involved 
is  many  years  old  and  the  language  of  the  contract  is 
hardly  less;  with  a  few  minor  changes  the  expression 
of  the  obligation  is  practically  what  it  was  more  than 
fifty  years  ago.  Just  when  the  instrument  was  first 
called  bond  is  not  clearly  established  but  similar  docu- 
ments of  other  names  and  performing  much  the  same 
functions  were  in  use  as  long  as  one  hundred  and  fifty 
years  ago.  With  the  development  of  corporate  enter- 
prise the  bond  has  become  a  prominent  factor  in  that 
field;  earlier  than  twenty-five  years  ago  it  was  most 
prominent  in  federal  and  municipal  finance. 

Thus  it  is  seen  that  from  its  genesis  the  bond  has 
been  peculiarly  a  corporation  instrument  which  sug- 
gests a  most  natural  inquiry  as  to  why  an  individual 
or  partnership  could  not  make  an  issue  of  bonds  to 
advantage.  While  there  is  no  prohibition  whatever 
of  such  a  course,  there  are  a  number  of  obstacles  in 
the  way  of  success.  The  final  and  most  essential  act 
in  the  issuing  of  bonds  is  to  find  a  market  in  which  to 
convert  them  into  cash,  and  the  difficulty  of  accomplish- 
ing this  is  the  chief  stumbling  block  to  any  other  than 
corporate  issues.  The  market  reflects  the  world's 


6  Investment  Bonds 

judgment;  and  this  judgment,  already  pronounced,  is 
that  the  value  of  a  contract  of  an  individual,  to  deliver 
money  so  far  off  as  fifteen  or  twenty  years,  is  uncertain. 
For  a  period  of  a  few  weeks  or  months  the  world  may 
be  reasonably  sure  of  his  position  and  integrity;  but 
the  vicissitudes  of  life  and  business  do  not  warrant  a 
judgment  of  the  future  beyond.  Inability,  therefore, 
to  find  a  market  for  long  term  bonds  necessitates  the 
use  of  notes,  commonly  called  commercial  paper,  or 
some  other  method  of  obtaining  funds. 

Many  of  the  uncertainties  about  the  future  of  an 
individual  in  business  are  common  to  partnerships. 
They  have,  in  rare  instances,  issued  bonds  but  a  broad 
attempt  to  do  so  would  be  unsuccessful.  The  possi- 
bilities of  failure  and  dissolution,  or  of  termination  by 
some  other  of  a  number  of  conditions  which  could 
bring  it  about,  makes  the  use  of  notes  likewise  largely 
incumbent  on  partnerships. 

Coming  to  corporations,  we  find  an  absence  of  most 
of  these  features.  They  do  issue  notes  largely,  but  it 
is  generally  exigencies  of  the  moment  that  demand 
such  action.  A  corporation  well  founded  usually  lives 
on  perpetually,  is  not  affected  by  deaths,  does  not  feel 
the  burdens  of  depressions  in  business  as  do  individuals 
and  partnerships  and  is  little  liable  to  failure  and  disso- 
lution. Under  such  conditions  it  is  manifestly  possible 
to  issue  long  term  obligations  and  to  find  a  favorable 
market.  Moreover,  the  plan  and  scope  of  business  in 
corporate  form  necessitates  a  more  permanent  use  of 
funds  than  can  be  obtained  through  notes,  hence  the 
issue  of  bonds. 

In  its  legal  aspects  the  investment  bond  presents  a 
practically  limitless  field  for  investigation  and  study 
in  both  extent  and  interest.  In  its  general  classifica- 


Introductory  7 

tion,  it  comes  under  the  head  of  contracts,  being  a 
formal  writing  sealed  and  delivered,  which  contains  an 
agreement  setting  forth  terms  and  conditions  and 
which  serves  as  a  proof  of  an  obligation.  From  this 
viewpoint  the  chief  characteristic  of  an  investment 
bond  is  that  it  is  a  conditional  contract ;  but  requiring 
future  action  by  one  party  only,  this  action  being  the 
payment  of  a  certain  amount  of  money  and  the  party 
being  the  issuing  corporation. 

In  a  further  legal  classification  it  falls  in  the  category 
of  negotiable  instruments.  Generally  speaking,  it  is 
negotiable  paper,  transferable  by  sale  or  delivery  and 
endorsement.  This  must  be  qualified,  however,  as  not 
all  bonds  are  transferable  by  sale  and  delivery.  The 
technical  designation  of  those  that  pass  by  delivery  ' 
is  coupon  bond.  The  others  are  known  as  registered 
bonds,  which,  to  be  negotiable,  must  bear  the  owner's 
endorsement.  This  constitutes  a  contract  of  assign- 
ment. Their  designation  indicates  the  necessity  of  a 
written  account  or  entry  to  complete  the  process  of 
negotiation. 

From  a  financial  viewpoint,  bonds  are  in  effect 
promissory  notes,  differing  of  course,  from  that  specific 
instrument,  as  already  stated,  in  the  matter  of  length 
of  life.  Alike,  however,  they  must  be  cancelled  by 
payment  or  the  debt  must  be  satisfied  in  some  other 
way.  The  bond  is  generally  a  direct  obligation  of  the 
issuing  corporation,  and  a  credit  obligation  representing 
or  being  secured  by  a  lien.  It  has  been  shown  that  the 
stockholder's  interest  in  a  corporation  is  proprietary 
— he  is  at  least  a  partial  owner ;  the  management  of  the 
business  is  conducted  indirectly  by  him.  His  claim 
is  on  the  profits  of  business  after  all  expenses  have 
been  met  and  is  therefore  indefinite  in  amount  and 


8  Investment  Bonds 

contingent  in  nature.  While  the  company  remains 
solvent  his  claim  is  to  dividends,  a  claim  which  is  unen- 
forceable by  process  of  law.  His  contribution  to  the 
business  is  made  with  no  contract  for  its  repayment 
nor  any  increment,  and  his  interest,  as  of  a  partner, 
is  to  bring  his  company  to  a  position  of  greatest  effi- 
ciency and  largest  earning  power  to  make  the  payment 
of  dividends  expedient.  A  bondholder's  position  is 
vitally  different.  The  obligation  he  holds  is  a  contract 
binding  the  company  to  pay  a  certain  amount  of 
money,  defining  him  therefore  as  a  creditor,  with  no 
interest  in  the  company  save  the  desire  to  see  it  so 
conducted  as  to  be  able  to  meet  its  obligations.  Con- 
sequently, he  has  no  voting  power  to  direct  the  man- 
agement. As  a  general  statement,  this  last  is  true, 
except  in  special  instances  of  which,  however,  there 
are  few.  The  bondholder's  claim  is  absolute  and  he 
generally  has  security  for  the  payment  of  his  contract. 
Priority  of  his  claim  on  income,  therefore,  generally 
enables  him  to  take  action  if  the  company  is  delinquent, 
while  a  greater  prosperity  of  the  company  does  not 
affect  him  since  he  is  entitled  to  a  definite  amount  only. 
The  exact  purposes  for  which  bonds  are  issued  are 
varied  and  numerous.  Every  corporation  has  its 
particular  and  peculiar  needs.  One  organized  pri- 
marily for  private  gain  issues  bonds  and  the  funds 
obtained  by  this  method  are  called  capital.  The  corpor- 
ation existing  solely  for  public  welfare  issues  bonds  also, 
but  these  funds  are  not  called  capital,  although  cor- 
responding practically  to  what  is  known  as  working 
capital  in  commercial  operations.  Considering  largely 
the  former  kind  of  corporation  in  a  treatise  of  this 
nature,  it  may  be  broadly  stated  that  bonds  are  issued 
for  capitalization  purposes.  To  be  exact,  the  capital 


Introductory  9 

of  a  company  is  only  those  funds  obtained  through 
stock  issue  but  since  conditions  have  brought  about 
the  floating  of  such  large  and  varied  amounts  of  bonds, 
they  are  now  fully  recognized  as  part  of  capital.  In- 
deed, whole  properties  have  been  produced  by  bond 
issues  alone. 

Most  corporations,  of  any  description,  have  out- 
standing bond  issues  but  withal  there  are  some  notable 
exceptions.  Some  states  have  none,  and  at  least  one 
great  railroad,  the  Chicago  Great  Western,  has  no 
bonded  debt,  so-called,  this  company  being  controlled 
by  foreign  interests  and  financed  by  methods  some- 
what different  from  those  employed  by  American 
companies. 

Capitalization  by  bond  issues,  while  not  distinctively 
an  American  practice,  reaches  here  its  broadest  devel- 
opment. Taking  the  capitalization  of  railroads  as 
embodying  many  principles  of  finance  we  find,  for  ex- 
ample, a  striking  dissimilarity  between  English  and 
American  methods.  The  English  policy  aims  to 
provide  most  improvements  through  stock  issue;  the 
American  policy  through  bond  issue.  In  scope,  Ameri- 
can railway  financing  is  very  broad  and  provides  our 
railways  with  resources  not  only  to  improve  and  better 
their  properties,  but  enables  them  to  reach  out  and 
acquire  additional  properties.  What  may  be  said  of 
railways  on  this  point  is  true  in  large  measure  of  manu- 
facturing corporations;  original  and  new  construction, 
improvements  and  acquisition  of  additional  properties 
by  stock  control  or  otherwise,  are  primarily  the  purpose 
of  their  bond  issues.  Consolidation  and  extension,  so 
largely  effected  through  bond  issue,  generally  enables 
a  more  efficient  and  profitable  operation. 

Municipalities  and    governments  may  issue  bonds 


io  Investment  Bonds 

for  general  and  specific  purposes  many  of  which  are 
well  known.  Sometimes,  when  the  ordinary  expendi- 
tures of  the  Government  exceed  its  income  for  a  pro- 
tracted period,  an  issue  of  short  term  bonds  may  be 
made  so  as  to  obviate  the  necessity  of  heavy  taxation. 
Public  works,  both  government  and  municipal,  are 
nearly  always  financed  in  this  way.  The  expediency 
of  issuing  bonds  sometimes  involves  a  basic  principle 
of  finance,  especially  in  the  initial  capitalization  of  a 
corporation.  At  other  times,  the  advisability  of  this 
method  of  obtaining  funds  is  determined  solely  by 
conditions.  Business  conditions,  the  credit  of  the 
company,  the  disposition  of  the  stockholders  and 
management  are  all  elements  affecting.  Whether  to 
incur  a  floating  debt,  make  a  new  stock  issue  or  shoulder 
a  bond  issue  must  be  carefully  considered.  More  stock 
may  mean  a  more  scattered  ownership  with  the  possi- 
bility of  loss  of  control  by  certain  interests,  and  the 
distribution  of  future  profits  among  a  larger  number 
(assuming  that  the  original  stockholders  could  not 
take  up  the  issue) — it  may  mean  the  returns  would  be 
irregular  inasmuch  as  shares,  because  of  their  insta- 
bility generally,  often  do  not  commend  themselves  to 
investors  as  highly  as  bonds;  a  note  issue  may  mean 
a  high  interest  rate,  of  course,  for  a  comparatively 
short  time,  but  with  possible  expenses  of  renewal  and 
discounts;  a  bond  issue  may  mean  an  interest  charge 
for  a  considerable  period  of  years  to  the  extent  of  en- 
dangering dividends  but  it  may  also  mean  a  good 
return  and  a  greater  earning  power:  all  these  things 
are  kept  in  mind  when  the  question  of  increased 
capitalization  is  considered.  The  proceeds  of  notes, 
however,  are  not  considered  as  capital.  After  a  com- 
pany has  determined  upon  an  issue  of  bonds,  it  has 


Introductory  1 1 

still  another  problem  to  solve — the  kind  of  bond  to 
put  out.  In  its  solution  the  potent  factors  are  largely 
external  conditions.  Nevertheless,  everything  must 
be  considered.  While  municipal  and  government 
financial  operations  are  not  affected  by  personal  con- 
siderations, they  too  must  be  conducted  with  due 
regard  for  conditions.  A  state  of  depressed  municipal 
credit,  for  instance,  would  be  an  unpropitious  time 
for  a  bond  issue  of  that  nature. 

It  is  interesting  to  glance  at  the  figures  showing  the 
aggregate  and  comparative  amounts  of  bond  obliga- 
tions outstanding.  Staggering  as  they  are  they  tell 
but  a  part  truth.  To  arrive  at  anything  more 
than  an  approximation  of  some  of  these  figures  is 
impossible  for  a  number  of  reasons.  The  absence  of 
public  record  precludes  accuracy  for  statistical  pur- 
poses ;  and  no  such  record  is  obtainable  of  many  millions 
of  bonds  that  are  put  out  each  year,  for  the  reason  that 
they  are  never  put  on  public  sale;  they  pass  directly 
from  the  issuing  company  to  investors  closely  associated 
with  it.  Where  this  occurs  the  issuing  company  is 
usually  comparatively  small.  The  larger  corporations, 
as  a  rule,  bring  their  securities  into  the  public  market. 

There  is  an  index,  however,  to  the  trend  and  extent 
of  bond  issue — the  great  Exchanges  of  the  country. 
Through  these  passes  the  greater  part  of  the  bonds 
issued  by  manufacturing  and  railroad  corporations 
and  the  Government,  but  not  of  municipalities.  Nearly 
ninety  per  cent,  of  municipal  bonds  never  reach  the 
Exchanges,  passing  to  investors  over  the  counters  of 
brokers  and  bankers.  By  a  study  of  the  bonded  in- 
debtedness of  the  thousands  of  municipalities  of  the 
country,  it  will  readily  be  seen  that  Stock  Exchange 
figures  are  far  from  complete.  The  item  of  municipal 


12  Investment  Bonds 

bonds  in  the  security  markets  is  very  large  and  im- 
portant and  the  aggregate  is  probably  even  greater 
than  the  entire  Government  debt.  These  facts  must 
ever  be  kept  in  mind  in  reading  published  statistics. 

In  recent  years  there  has  been  a  large  increase  in 
bond  issue  and  the  aggregate  figures  available  show  a 
large  amount  in  excess  of  stock  issues.  On  the  three 
hundred  thousand  miles  of  railways  in  the  United 
States  there  is  approximately  a  funded  debt  of  eight 
billions  of  dollars.  Statistics  indicate  that  the  rail- 
roads produce  about  sixty  per  cent,  of  the  bonds  ac- 
counted for,  while  the  remaining  forty  per  cent,  is 
approximately  divided,  ten  per  cent,  for  industrials, 
ten  per  cent,  for  Government,  and  twenty  per  cent, 
for  municipal  bonds.  The  figures  of  the  New  York 
Stock  Exchange  show  that  the  railroads  produce  the 
bulk  of  the  bonds  listed  there  and  these  railroads  are 
practically  all  parts  of  about  twelve  great  systems. 
They  also  show  that  the  increase  in  bond  issue  during 
the  year  of  1905  was  fully  fifty  per  cent,  more  than 
either  of  the  two  previous  years,  the  figures  for  1905 
being  $643,396,000.  This  total  for  1905  was  exceeded 
by  only  three  other  years  during  the  past  twenty, 
namely,  1890,  1898,  and  1901.  The  average  amount 
for  the  past  twenty  years  is  practically  $483,000,000 
and  for  the  past  ten  years  $583,000,000.  The  year 
1901  gives  a  total  of  something  over  $923,000,000 
which,  however,  cannot  be  fairly  considered  in  the 
calculation  as  it  is  misleading;  in  that  year  the  great 
United  States  Steel  Corporation  was  organized  and 
many  securities  were  issued  to  replace  old  securities 
of  companies  taken  over.  During  the  year  1904,  the 
total  of  bonds  issued  was  nearly  four  times  as  great 
as  stocks  for  the  same  year. 


Introductory  13 

It  would  be  natural  to  suppose  that  coming  from 
so  many  sources  there  is  great  diversity  in  the  makeup 
and  processes  of  issue  and  negotiation  of  bonds.  This, 
however,  is  not  the  case.  Multitudinous  and  varied 
as  are  the  uses  of  funds  obtained  thus,  there  is  never- 
theless a  marked  uniformity  in  general  practice  with 
respect  to  the  instrument.  Much  the  same  general 
principles  and  conditions  govern  in  all  cases.  Whether 
it  be  an  issue  by  some  great  railroad  or  some  small 
industrial  corporation;  a  funding  operation  by  some 
great  government  or  for  a  small  rural  school  district; 
a  five  hundred  million  dollar  issue  or  one  of  ten  thousand 
dollars,  certain  things  are  obligatory  and  others  ex- 
pedient if  ultimate  success  is  to  be  obtained.  The 
methods  employed  in  funding  operations,  great  and 
small,  vary  not  a  great  deal  in  principle.  A  large 
measure  of  uniformity  has  become  a  practical  necessity. 
Considerations  of  safety,  success  in  marketing,  and 
high  return  are  all  great  factors  in  bond  issue. 


CHAPTER  II. 

CLASSIFICATION. 

AMERICAN  financiers  have  often  been  under  necessity 
of  producing  a  security  with  new  and  attractive  fea- 
tures. At  times  distinctive  and  peculiar  conditions 
have  had  to  be  met.  With  characteristic  ingenuity 
they  have  usually  succeeded,  in  consequence  of  which 
there  is  now  a  diversity  of  securities  that  quite  demand 
close  study  for  a  full  appreciation  of  their  scope  and 
nature.  Great  corporate  needs  have  produced  volume, 
coincident  with  which  have  been  developed  two  charac- 
teristics of  the  bond  branch  of  the  security  market, 
variety  and  novelty.  The  average  investor  is  per- 
plexed to  distinguish  various  issues  so  he  may  make 
a  conservative  judgment.  He  is  not  alone.  Many 
another,  though  familiar  with  finance,  is  nonplussed 
to  make  a  clear  and  comprehensive  classification. 
Some  difficulty  arises  from  difference  of  name  where 
the  issues  are  identical  with  the  exception  of  some  un- 
important feature.  When  the  chief  characteristic  or 
some  distinctive  feature  is  taken  as  a  basis,  the  task 
is  comparatively  easy;  but  beyond  such  general  dis- 
tinctions classification  becomes  somewhat  involved. 
Several  are  used  by  financial  writers,  differing  in 
detail  yet  built  upon  practically  the  same  foundation. 
All  are  essentially  correct.  Indeed  it  is  impossible  to 

14 


Classification  15 

make  an  arrangement  of  bonds  admitting  of  no 
variation. 

The  most  general  is  to  group  them  under  one  or  the 
other  of  two  heads,  namely,  Mortgage  and  Debenture 
bonds.  Enlarging  somewhat  upon  this  they  are 
grouped  as  Mortgage,  Equipment,  Land  Grant,  Col- 
lateral Trust,  Prior  Lien,  Debenture  and  Income,  which 
is  about  the  greatest  number  of  general  groups  prac- 
ticable; a  finer  division  immediately  emphasizes  dis- 
tinctions of  individual  issues.  From  a  market  point 
of  view  solely,  bonds  and  funded  investments  are  often 
put  into  three  divisions,  railway,  industrial,  and  miscel- 
laneous. From  this  same  point  of  view,  under  miscel- 
laneous bonds  are  included  industrial  issues  and  so 
making  this  division  to  consist  of  issues  of  foreign 
governments,  public  service  corporations  and  indus- 
trial companies.  The  present  classification  proceeds 
differently  by  presenting  the  bonds  arranged  under 
corporate  groups  and  then  considering  the  individual 
issues. 

Before  discussing  the  bonds  it  is  expedient  to  con- 
sider the  issuing  corporations,  with  a  brief  inquiry  into 
their  nature  and  classification.  Though  not  prere- 
quisite to  an  understanding  of  the  subject  such  general 
knowledge  contributes  measurably  toward  a  clear  con- 
ception of  the  nature  and  functions  of  the  various 
bonds.  It  is  important  to  know  in  what  division  each 
corporation  lies  and  in  a  general  way  what  types  of 
bonds  it  issues. 

Of  corporations  there  are  three  kinds :  Public,  Quasi- 
Public,  and  Private,  their  names  indicating,  in  a  meas- 
ure, their  functions.  The  public  corporation,  very 
generally  called  municipal,  is  a  political  division  em- 
powered by  law  to  do  such  acts  as  are  necessary  for 


1 6  Investment  Bonds 

the  well  being  and  advancement  of  the  common- 
wealth ;  its  particular  functions  are  many  and  it  is  con- 
ducted for  no  gain  save  the  public  good ;  its  operations 
are  limited  to  the  territory  over  which  it  has  jurisdiction 
and  its  officers  are  largely  elected  by  its  citizens. 
Municipal  corporations  are  classified  by  law,  generally 
according  to  population  and  assessed  valuation,  and 
their  powers  are  defined  according  to  class.  Cities  and 
counties  are  representative  examples.  The  private 
corporation  is  exactly  the  opposite;  it  is  formed  for 
pecuniary  gain  and  its  activities  may  be  universal;  it 
gets  its  being  and  powers  from  the  law,  and,  when  not 
violating  its  provisions,  is  not  amenable  in  any  sense. 
In  organization  and  operation  it  is  entirely  different 
from  the  public  corporation  and  is  typified  in  a  manu- 
facturing company.  Quasi-public  corporations  par- 
take of  the  nature  of  both  public  and  private,  though 
in  law  they  are  considered  as  of  the  latter  kind.  Their 
services,  nevertheless,  are  essentially  public — hence 
the  classification.  Formed  primarily  for  private  gain, 
they  have  rights  that  are  strictly  private  and  beyond 
legislative  control,  yet  they  may  be  subjected  to  con- 
siderable regulation  by  State  and  Federal  authorities. 
The  steam  railroads  and  public  service  corporations 
fall  in  this  category.  Of  those  corporations  other 
than  public,  there  are  many  whose  status  is  not  yet 
clearly  and  finally  defined  since  authorities  on  the  sub- 
ject are  divided.  The  best  legal  minds  are  far  from- 
unanimous  on  the  identity  of  some  corporations  in  so  far 
as  it  is  fixed  by  their  functions.  Whether  these  func- 
tions are  private  or  quasi-public  is  a  mooted  question. 
With  this  as  a  safe  basis,  investment  bonds  may  be 
classified  first  by  two  great  general  divisions,  putting 
into  one  those  issued  by  public  corporations  and  for 


Classification  1 7 

the  other  those  issued  by    private  and    quasi-public 
corporations. 

Considering  these  general  divisions,  in  the  first  we 
find  three  classes  under  which  may  be  grouped,  however 

designated  by  name,  all  of  such  securities 

uv  x-  T>  •       Municipal 

issued  by  public  corporations.  Every  muni- 
cipality is  under  the  necessity  of  maintaining  public 
works  and  making  improvements,  such  as  building  of 
bridges,  sewers,  and  waterworks  to  finance  which  it  is 
generally  necessary  to  issue  bonds.  Part  of  this  funded 
debt  is  often  known  as  corporate  stock  which  is  only 
those  long  term  bonds  issued  for  permanent  improve- 
ments in  distinction  to  the  assessment  bonds  issued 
to  provide  funds  for  all  work  done  by  contract,  the 
expense  of  which  is  to  be  collected  by  assessment  from 
property  benefitted  by  the  work.  Likewise  every  State 
has  similar  duties ;  additional  highways  may 
be  needed — a  canal  may  be  demanded  by 
business  conditions — the  requirements  for  educational 
purposes  may  be  enlarging,  for  all  of  which,  after  the 
proper  legislative  authorization,  the  funds  are  usually 
provided  by  an  issue  of  bonds. 

The  Federal  Government  too,  has  many  matters  to 
look  after.     Its  duties  are  all  public,  of  course,  but 
their  scope  is  much  broader.     It  must  finance 
such  projects  as  are  authorized  by  proper  „ 

17  '    r      r       Government 

legislation.  Building  a  canal  such  as  the 
Panama,  for  instance,  would  generally  be  financed  by 
bond  issue,  as  would  the  prosecution  of  a  war.  The 
general  acceptation  of  the  term — Municipal — as  applied 
to  bonds,  contemplates  those  minor  civil  divisions 
smaller  than  a  State  although,  strictly  speaking,  all 
public  corporations  are  municipal. 

In  the  second  general  division,  private  and  quasi- 


i8  Investment  Bonds 

public  corporations,  there  are  a  greater  number  of 
classes.  Every  progressive  manufacturing  company 
has  need  for  new  capital  from  time  to  time ; 
growth  of  business  means  enlargement  of 
plant  or  acquirement  of  other  plants.  To  -finance 
these  operations,  in  part  at  least,  bond  issues  are  often 
made.  Consolidation  and  extension  of  the  great  net 
work  of  steam  railways  throughout  this  country  pro- 
duces great  amounts  of  bonds;  the  railways 
Railroad  unceasingly  increase  their  mileage  and  im- 
Traction  Prove  their  facilities.  Numerous  traction 
lines,  which  operate  largely  in  cities,  also 
produce  a  considerable  amount  of  bonds.  The  mar- 
vellous development  of  electric  motive  power  has  given 
a  great  stimulus  to  this  form  of  enterprise,  and  much 
of  the  necessary  capital  is  obtained  through  bond  issue. 
Another  source  from  which  many  bonds  are  put  into 
the  market  are  public  service  corporations. 
Service  ^e  raP^  growth  of  the  country  necessitates 
installation  of  public  utilities  everywhere, 
and  accordingly  new  water  works  are  built,  new  gas, 
electric,  and  power  plants  are  constructed  and  tele- 
phone facilities  extended.  The  call  for  funds  in  this 
direction  is  largely  met  by  issue  of  this  kind  of  security. 
Still  other  bonds,  although  comparatively  few,  are 
placed  on  the  market — those  issued  by  navigation 
lines  whose  needs  are  similar  to  those  of  other  trans- 
portation companies  in  the  way  of  new  equipment,  new 
and  larger  terminals,  etc.,  and  which  are  provided  to 
some  extent  by  bond  issues. 

Considering  issues  individually,  some  are  found  to 
be  the  natural  product  of  the  growth  of  corporations. 
Any  corporation  may  issue  a  type  of  improvement  bond 
to  finance  specific  or  general  permanent  improvements 


Classification  19 

and  if  there  is  definite  security,  a  condition  wholly  de- 
pendent upon  the  kind  of  corporation,  it  generally  takes 
the  form  of  an  encumbrance  on  the  property 
benefited.  The  railroads  are  practically  Imp™™~ 
alone  in  issue  of  what  are  known  as  exten- 
sion and  construction  bonds,  both  of  which  finance 
the  building  of  new  trackage,  and  are  usually  secured 
by  a  first  mortgage  on  the  property  created ; 
their  issue  is  progressive  with  the  work.  Extension 
Again  railroads  often  buy  up  other  railroad 
properties  and  sometimes  need  more  land 
for  terminals.  An  issue  of  purchase  money 
bonds  may  be  made,  secured  by  a  lien  on  the  property 
obtained.  This  acquired  property  may  have  a  debt, 
and  where  such  is  the  case,  the  purchaser 
usually  provides  for  it.  Howrever,  this  is 
not  exclusively  a  railroad  type  although 
practically  all  of  this  name  have  come  from  that  source. 
It  is  frequently  necessary  for  a  railroad  to  increase  the 
number  of  its  cars  to  care  for  growing  business,  and 
there  may  be  no  other  available  means  of  obtaining 
necessary  funds  save  through  an  issue  of 
" Car-Trust"  or  equipment  bonds.  Strictly"° 
speaking,  a  "Car-Trust"  bond  (or  certificate, 
as  it  is  sometimes  known),  is  an  obligation 
issued  by  a  concern  known  as  a  car  trust.  Its  security 
is  the  cars,  which  have  been  purchased  from  a  manu- 
facturing company  and  rented  to  a  railroad  company 
until  full  payment  is  made,  periodical  payments  being 
provided  for,  which  go  to  make  payments  on  the  bonds. 
The  equipment  obligation  differs  in  that  it  is  not  issued 
by  a  car  trust  and  is  somewhat  broader  in  scope,  in- 
cluding, as  it  may,  locomotives,  boats,  etc.  This  dis- 
tinction should  be  remembered  for  yet  another  reason, 


20  Investment  Bonds 

and  that  is,  that  equipment  bonds  are  not  necessarily 
railroad  issues:  a  manufacturing  company  may,  quite 
as  well,  put  out  such  bonds  to  purchase  machinery 
and  equipment. 

A  bond  rarely  used  in  this  country  but  quite  well 
known  abroad  is  termed  founders.      It  is  generally 

given  to  the  promoters  of  an  enterprise  in 
Founders  ^  na^ure  of  a  bonus  in  a  similar  manner 
that  stock  is  given  in  this  country.  Technically,  it 
may  be  considered  more  as  stock  than  as  a  bond  though 
it  is  often  designated  by  the  latter  term.  Accompany- 
ing the  universal  tendency  toward  corporate  consolida- 
tion has  come  the  necessity  of  bond  issues  adapted  to 

this  condition.  To  this  end  we  have  such 
General  securities  as  general  mortgage  bonds  which 

may  be  issued  by  any  corporation  other  than 
public  and  are  generally  secured  by  a  lien  on  the  property 
in  its  entirety.  In  scattered  instances  they  constitute 
a  first  lien;  but  are  generally  subject  to  some  prior 
liens.  Akin  to  this  are  consolidated  and  "Blanket" 
Mortgage  bonds.  The  former  usually  puts  a  new 
security  on  an  entire  group  of  properties  already  fully 

covered  individually  and  while  therefore 
Consoli-  secured  by  a  mortgage  on  all  the  properties, 
"'sianket"  tn^s  ^n  t°°  is  generally  subject  to  some  of 
Mortgage  prior  right.  Scarcely  any  distinction  is  to 

be  made  between  the  so-called  "Blanket" 
mortgage  bond  and  the  two  others  just  mentioned. 
The  term  is  generic  in  its  significance  and  whenever 
used,  which  is  seldom,  is  little  else  than  synony- 
mous— it  may  aptly  describe  either  of  the  others. 
In  the  issue  of  such  comprehensive  mortgages  pro- 
vision is  almost  invariably  made  for  refunding  other 
issues  as  they  mature,  these  issues  being  much  smaller 


Classification  21 

and  generally  a  prior  lien  and  being  provided  for  by 
an  arrangement  for  their  exchange  for  the  proper 
amount  of  the  larger  issue.  Very  frequently,  however, 
issues  are  made  specifically  designed  for  the  purpose 
of  refunding,  which  gives  the  name  to  a  very  large 
amount  of  bonds  at  present  in  the  market.  Any 

kind  of  a  corporation  may  issue  these,  which 

•   „  -  r         r  Refunding 

are  essentially  a  continuation  of  a  former 

debt  beyond  its  maturity.  When  the  maturing  bond 
is  not  retired  in  exchange  for  a  proportionate  amount 
of  the  new  issue,  it  is  cancelled  and  payment  made 
through  sale  of  part  of  the  issue.  Refunding  issues 
are  generally  as  well  secured  as  the  bonds  they  retire. 
A  few  corporations,  mostly  railroads,  have  found  it 
expedient  to  consolidate  much  of  their  funded  debt, 
covering  it  by  only  one  issue  of  bonds  known  as  unified. 
In  this  way  a  simplification  is  accomplished  by  uniting 
under  a  single  issue  a  mass  of  miscellaneous 
obligations.  The  advantages  to  be  derived 
from  this  procedure  are  not  a  few.  One  is  increased 
facility  of  management  of  the  debt — another,  the 
generally  better  market  which  the  new  security  enjoys 
over  those  it  displaces.  The  whole  operation  is  indeed 
in  most  respects  analogous  to  refunding.  What  differ- 
ences exist  are  unimportant. 

The  rehabilitation  of  many  corporations,  through 
rearrangement  of  their  finances,  before  or  after  a 
critical  point  was  reached,  evolved  a  number  of  types 
peculiar  to  such  conditions.  Rehabilitation  after  this 
manner  was  in  every  instance  a  form  of  re- 
organization out  of  which  came  such  bonds1160^"??*" 

_,  tion  Lien 

as  reorganization  lien.     The  characteristics 

of  these  issues  grew  out  of  the  attending  circum- 
stances and  they  were  generally  vested  with  only  a 


22  Investment  Bonds 

junior  lien  on  the  property  reorganized.  But  as  re- 
organization of  a  company  means  settlement  of  the 
claims  of  the  various  interested  parties  on  a  satisfactory 
basis,  there  has  been  issued  occasionally  a  form  of 
bond  in  many  respects  similar  to  the  last 
mentioned  and  called  adjustment.  Always 
an  outgrowth  of  such  conditions,  its  features  have  been 
determined  accordingly.  In  this  way  additional  capital 
for  improvements  has  been  realized,  while  a  lien,  only 
junior  in  its  preferment,  has  been  given.  An  excellent 
example  of  this  type  of  security  is  the  Atchison,  Topeka 
&  Santa  F6  four  per  cent,  adjustment  issue,  growing 
out  of  reorganization  of  that  road  in  1896.  The  suc- 
cess of  a  reorganization  plan  is  generally  dependent  upon 
the  ability  to  secure  additional  funds.  So  to  insure 
this,  it  has  sometimes  been  necessary  to  give 
a  preferential  claim  to  those  providing*  the 
funds.  A  Prior  Lien  bond  has  therefore 
been  issued.  Practically  all  such  issues  are  railroad 
obligations  secured  by  mortgage  but  are  not  always,  as 
might  naturally  be  supposed,  the  first  obligation  of 
the  issuing  company.  The  name  is  but  a  relative  term 
and  may  mean  no  more  than  that  the  bond  is  prior  to 
some  other  specified  issue.  As  mortgages  covering 
Prior  Lien  bonds  are  usually  general  in  character, 
embracing  much  property,  they  are,  like  all  such,  sub- 
ject to  other  liens.  The  distinction  therefore,  between 
Prior  Lien  bonds  and  those  having  a  prior  lien  is  to  be 
marked.  The  Erie  Railroad,  among  others,  has  a 
representative  Prior  Lien  issue. 

Insolvency  and  reorganization  produce  still  another 
bond.  At  such  times  concessions  are  required  of  some 
security  holders,  and  for  the  compensation  of  those 
making  the  sacrifice  there  is  issued  the  income  bond. 


Classification  23 

With  few  exceptions,  this  has  been  its  origin;  it  is, 
however,  fast  disappearing  from  the  lists.  Briefly 
stated,  it  is  an  obligation  the  interest  on  which 
is  payable  out  of  net  earnings  after  all  fixed 
charges  have  been  met.  Interest,  therefore,  is  con- 
tingent, being  entirely  dependent  upon  the  earnings 
of  the  company  and  still  further  uncertain,  in  that  it 
is  payable  or  not  in  the  discretion  of  the  management. 
Sometimes  it  is  cumulative,  standing  as  a  charge  ahead 
of  all  dividends  on  the  stock.  Generally  such  bonds 
are  mortgage  secured  as  to  principal  and  are  always 
a  junior  lien. 

The  status  of  an  income  bond  may  be  changed  by 
agreement.     Absorption  of  a  small  line  of  railway  by 
a  great  system  usually  brings  about  a  modi- 
fication of  the  securities  of  the  former;  the      Assented 

Income 
larger  company  may  wish  to  withdraw  certain 

issues,  for  which  privilege  it  makes  attractive  offers 
to  the  holders.  In  the  case  of  the  assented  income 
bond  a  fixed  and  regular  interest  return  is  assured 
where  formerly  it  was  contingent.  For  this  the  com- 
pany is  given  some  privilege,  say  perhaps  to  retire 
them  before  maturity  at  a  stipulated  price.  Con- 
currence of  the  bondholders  in  such  an  arrangement 
gives  rise  to  the  name. 

A  type  of  bond  which  came  into  prominence  and 
favor  within  the  past  few  years  but  whose  popularity 
is  now  waning,  is  that  which  depends  for  its 
safety  entirely  or  almost  entirely  upon  the       5  Trust 
pledge  of  other  securities  usually  taken  from 
the  treasury  of  the  issuing  company  or  system  and 
placed  in  trust,  under  the  terms  of  the  collateral  mort- 
gage,  to  secure   payment  of  principal   and   interest. 
These  securities  may  consist  wholly  or  in  part  of  stocks 


24  Investment  Bonds 

or  bonds,  and  are  generally  the  obligations  of  auxiliary 
companies.  Up  to  about  the  year  1900,  bonds  were 
extensively  used  as  security  and  nearly  all  of  first  and 
second  mortgage;  subsequently,  deposit  of  stock  only 
became  the  general  practice.  Under  variously  named 
issues,  practically  all  of  the  railways  and  many  other 
corporations  report  large  collateral  trust  mortgages. 
Many  such  issues  have  found  their  source  in  the  holding 
company,  a  corporation  having  no  independent  credit 
and  usually  operating  no  properties  and  whose  assets 
consist  largely  of  stocks  and  bonds  of  other  companies. 
In  fact,  this,  with  but  one  other  kind,  the  debenture, 
is  the  only  bond  obligation  such  a  company  can  issue. 
A  large  number  of  companies  are  both  holding  and 
operating,  when  of  course,  they  may  issue  any  kind. 
Typical  examples  of  a  purely  holding  company  were 
to  be  found  in  the  Northern  Securities  Company  and 
the  United  States  Steel  Corporation  when  it  was  first 
organized.  At  present,  the  United  States  Steel  Cor- 
poration, Pennsylvania  Railroad,  and  Union  Pacific 
Railroad  are  excellent  examples  of  companies  both 
holding  and  operating. 

What  may  be  a  collateral  trust  obligation  (though 
it  may  be  any  other)  is  the  joint  bond ;  as  such  it  was 
exemplified  in  the  Great  Northern-Northern 
Pacific  Joint  4*8  issued  in  1901  and  secured 
by  deposit  of  Chicago,  Burlington  &  Quincy  Rail- 
road stock.  Taking  this  as  representative,  it  is  a 
security  issued  by  two  or  more  companies,  (usually 
two)  each  company  being  liable  for  its  proportion 
of  the  bonds,  both  principal  and  interest.  Provision 
is  usually  made  that  should  either  company  default 
in  its  obligations,  the  company  not  defaulting  shall 
become  owner  of  the  entire  property  and  shall  become 


Classification  25 

liable  in  severally  upon  all  covenants  contained  in 
the  bonds. 

Past  success  in  the  flotation  of  some  large  blocks  of 
collateral  trust  bonds  may  be  attributed  to  one  or  more 
special  features  embodied.  An  expedient 
that  has  been  used  is  permission  to  share 
beyond  the  regular  fixed  rate  of  interest  in 
profits  that  might  accrue  under  certain  conditions. 
The  arrangement  as  generally  carried  out  allows  par- 
ticipation to  a  specified  proportion  in  any  increased 
dividend  that  may  be  declared  on  the  underlying  stock 
collateral.  A  notable  example  was  the  Oregon  Short 
Line  R.  R.  4$  issued  in  1902.  Another  bond  that 
en j  oys  the  possibility  of  larger  return  through  increased 
income  or  profits  on  underlying  collateral  is  that  known 
as  profit  sharing.  The  form  is  very  seldom  used,  the 
best  known  issue  being  that  of  the  London 
Underground  Electric  Railways.  Its  se- 
curity  lies  in  deposit  of  stock  as  a  basis, 
which  stock  is  deposited  at  a  certain  price,  the  provisions 
of  the  mortgage  permitting  its  sale  when  the  market 
assures  a  profit,  the  sale  price  of  course  being  above 
that  at  which  the  stock  was  deposited  as  collateral. 
In  the  event  of  disposition  of  the  stock  prior  to  the 
due  date  of  the  bonds  the  holders  share  in  the  profits 
realized  from  such  sale. 

The  convertible  bond  is  the  embodiment  of  another 
idea  involving  profit-sharing  provisions.  Very  fre- 
quently a  corporation  cannot  issue  stock 

*-.-.,         ,       ,     Convertible 
to  advantage  as  a  means  of  obtaining  funds 

for  its  needs  and  is  therefore  restricted  to  some  method 
entailing  pledge  of  its  property  or  credit.  Prevail- 
ing conditions  may  hold  out  large  promises  of  success 
for  an  issue  of  convertible  bonds  as  the  only  type 


26  Investment  Bonds 

exactly  filling  the  requirements  of  the  situation.  This 
privilege  of  conversion,  the  feature  of  this  type,  is 
incorporated  in  the  mortgage  and  allows  the  holder 
to  convert  his  security  into  some  other  form  of  obli- 
gation, usually  stock,  within  a  specified  time  and  at 
a  specified  rate.  What  may  become  the  source  of 
profit  is  the  possible  high  market  price  on  the  stock 
at  the  time  the  privilege  is  exercised.  By  then  ex- 
changing the  bonds  for  stock  and  turning  that  into  the 
market  a  substantial  profit  could  be  realized.  A  high 
quotation  for  the  stock  substantially  indicates  sound 
business  conditions  and  increased  profits  in  which  the 
convertible  bond  holder  is  thus  privileged  to  share. 

Most  bonds  run  for  a  definite  period  of  time ;  that  is, 

they  are  intended  to  live  out  their  allotted  number  of 

years.     Among  those  otherwise  designed  are 

Sinking       some  subject  to  repurchase  by  the  issuing 

Fund  Re-  ...  .  .-    ,  * 

deemable     corporation  within  a  specified  time  or  at  a 

certain  date.  To  accomplish  this  a  certain 
amount  of  money  is  set  aside — more  often  annually— 
to  retire  the  bonds  at  that  time.  It  is  customary  with 
many  municipal  and  public  service  corporations  and 
also  with  nearly  all  companies  whose  assets  are  gradu- 
ally depleted  by  the  operations  of  business  to  follow 
this  plan,  thus  establishing  what  is  known  as  a  Sinking 
fund.  All  bonds  that  may  be  retired  in  that  way  are 
so  called.  Sinking  fund  bonds  of  all  but  public  cor-, 
porations  are  generally  protected  by  a  mortgage, 
which  contains,  if  the  bond  itself  does  not,  the  provisions 
relative  to  the  operation.  When  bonds  are  subject 
to  a  sinking  fund,  or  liable  to  be  retired  at  the  option 
of  the  maker,  they  are  said  to  be  redeemable. 

In  contradistinction  to  those  so  affected  are  some 
whose  life   is  practically  interminable,  sometimes  re- 


Classification  27 

f erred  to  as  perpetual  bonds.  Very  seldom  issued, 
they  are  an  obligation  whose  retirement  is  not  provided 
for  by  any  specified  date  of  maturity.  Ordi- 
narily this  would  necessitate  purchase  in  the  Irredeem- 
open  market  or  refunding  should  it  be  de-  able» Per" 
sirable  to  retire  them.  This  is  true,  of  course,  Annuity 
so  long  as  all  proper  conditions  exist.  Should 
default  in  interest  occur,  the  principal,  which  is  mortgage 
secured  where  not  a  public  corporation  obligation,  be- 
comes instantly  due.  The  same  principle  is  worked 
out  in  all  essential  particulars  in  the  annuity  bond 
whose  chief  characteristic  is  obviously  perpetuity. 
Of  this  last  type  very  few  companies  have  any  out- 
standing, those  most  prominent  being  the  Long  Island 
Railroad  and  Lehigh  Valley  Railroad  issues.  As  for 
irredeemable  bonds  as  a  class  they  are  not  numerous. 
Several  of  the  States — Kentucky  for  one — have  small 
amounts  and  about  an  equal  number  of  railroad  cor- 
porations have  a  few.  Further  examples  may  be 
found  in  British  Consols  and  the  Rentes  of  France  and 
other  foreign  countries,  though  they  differ  funda- 
mentally from  American  issues.  In  those  countries  no 
paper  evidence  of  debt  is  issued,  a  mere  record  of  the 
obligation  being  considered  sufficient. 

Under  property  classification,  bonds  become  subject 
to  the  laws  imposing  taxation.  But  not  all.  Those 
released  from  such  liability  are  thereby 

given  a  prominent  and  desirable  feature  and      Exempt, 

Non-ex- 
enjoying   this  privilege   are   called   exempt.  empt< 

But  the  term  exempt  is  used  in  another  sense 
—to  indicate   immunity   from  call   for   sinking  fund 
purposes.     This  fact  is  peculiar  to  a  few  issues  at  pre- 
sent in  the  market;  a  portion  only  is  subject  to  retire- 
ment by  such  a  fund  and  that  part  which  may  be  so 


28  Investment  Bonds 

retired  is  specially  designated  as  non-exempt.  Again, 
there  are  bonds  whose  life  might  be  uncertain  and  their 
value  unstable  were  they  to  remain  under  the  same 
conditions  as  issued.  Indeed  it  may  be  imperative 
through  reorganization  or  otherwise  that 
the  force  of  the  obligation  be  lessened  and 
its  terms  modified;  or  again,  new  or  different  privileges 
may  be  granted  to  the  holders  of  an  issue,  or  some 
mutual  agreement  may  be  made  involving  a  change  of 
conditions,  such  as  the  reduction  of  interest  or  the 
insertion  of  the  call  privilege.  The  record  of  such 
changed  conditions  is  usually  stamped  upon  the  bond 
and  thereby  becomes  a  part  of  the  instrument.  Of 
course,  any  bond  may  be  so  treated  and  would  then 
have  this  additional  qualifier,  stamped. 

One  of  the  conditions  frequently  included  in  a  bond 
contract  is  that  of  guarantee,  where  payment  of  either 
principal  or  interest  or  both  is  assured  by  the 
P10™86  °^  anot^er  corporation.  It  accepts 
the  liability,  contingently,  as  the  case  may 
be,  and  consequently  enhances  in  a  greater  or  less 
degree  the  value  of  the  obligation  as  an  investment. 
These  bonds  are  frequently  spoken  of  as  endorsed,  inas- 
much as  the  guarantee  is  quite  generally  given  by 
endorsing  the  instrument  to  that  effect. 

For  the  purpose  of  classification,  the   subsidy  bond 

may  justly  be  considered  as  a  guaranteed  obligation. 

Here,  by  pledging  itself  to  pay  the  interest  on  bonds 

issued  for  construction  purposes,  a  Government  assists 

in  establishment  and  support  of  an  enterprise  deemed 

advantageous  to  the  public.     Or  else,  what 

amounts  to  a  subsidy,  it  gives  special  rights, 

powers,  and  privileges,   and  perhaps  the   enjoyment 

of  absolute  or  conditional  immunity  from  taxation. 


Classification  29 

Formerly  municipalities  and  states  subsidized  largely, 
in  one  form  or  another,  but  it  is  no  longer  practicable, 
and  indeed  it  is  generally  impossible  for  them  to  do  so. 
Notwithstanding  this,  in  one  or  two  states  municipal  aid 
may  yet  be  extended  by  legislative  authority  in  exempt- 
ing from  taxation  or  by  endorsing  or  issuing  bonds  in 
the  case  of  gas  works,  water  works,  railroads,  etc. 
Thirty  years  ago  these  practices  were  widely  prevalent 
in  the  United  States,  principally  in  support  and 
encouragement  of  railroad  building.  Foreign  govern- 
ments still  employ  this  means  of  promoting  under- 
takings. Subsidizing,  however,  does  not  always  take 
the  form  of  payment  of  interest  or  principal  or  the 
bestowal  of  prerogatives.  Building  of  the 
great  transcontinental  lines  of  this  country  Grant 
was  made  possible,  at  the  time  they  were 
laid  down,  by  substantial  gifts  of  public  land  from  the 
Government.  Bonds  were  issued  to  raise  funds  for 
construction,  and  the  lands  were  pledged  under  a 
mortgage  for  their  redemption.  These  lands  were 
gradually  sold  and  the  proceeds  applied  to  pay  interest 
on  these  bonds  and  to  form  a  sinking  fund  to  retire 
them  eventually.  Most  of  these  bonds  have  been 
withdrawn  and  as  the  public  domain  is  not  now  large 
and  the  roads  originally  benefited  are  practically  in  a 
position  to  take  care  of  their  financial  needs  without 
governmental  assistance,  this  type  of  obligation  will 
soon  be  extinct.  Thus  it  is  that  land  grant  bonds  are 
distinctively  railroad  issues.  Beyond  these  gifts  of 
land  the  Federal  Government  rendered  no  material 
aid  to  roads  except  in  very  few  instances. 

Scarcely  less  distinctive  as  a  railroad  bond  is  that 
form  of  obligation  secured  by  mortgage  on  terminal 
property  and  usually  given  by  a  terminal  company. 


30  Investment  Bonds 

The  stock  of  such  a  company  is  generally  held  by  a 
road  or  association  of  roads  having  common  terminal 

facilities  and   known   as  a  Terminal    Corn- 
Terminal  ..  •     •     1       j., 

pany.    Provision  for  principal  and  interest  is 

made  by  payments  of  rental  by  each  company.  This 
is  the  general  practice  although  railway  companies  as 
such  have  issued  terminal  bonds,  their  interest  becom- 
ing a  proper  charge  on  the  revenues  of  the  company. 

The  integral  parts  of  nearly  all  great  railroad  systems 
bear  separate  mortgages  which  were  placed  upon  them 
before  their  consolidation.  These  parts  are 
Divisional  Designated  as  divisions,  and  the  bonds  is- 
sued for  their  account  are  secured  by  a  lien  on  the 
respective  part  only.  The  obligation,  however,  is 
that  of  the  parent  company,  the  term  merely  indicating 
that  the  security  given  is  some  specific  division  of  the 
property. 

Extremes  meet  when  we  consider  the  purely  first  mort- 
gage bond  and  the  debenture,  the  characteristic  of  the 
former  being  its  absolute  priority  of  lien.  A  bond  that 
may  rightfully  be  called  first  mortgage  is,  in  fact,  not 
subject  to  any  other  liens,  its  security  being 
Morf'a'e  a  mortgage  to  which  all  others  are  subse- 
quent. Strictly  speaking,  any  such  bonds 
should  be  protected  by  a  mortgage  senior  in  position  on 
all  the  property  denominated,  yet  in  practice  the  un- 
derlying mortgage  has  sometimes  been  made  first  on 
only  a  portion  of  the  property.  There  have  been  also' 
second,  third,  fourth,  and  fifth  mortgage  bonds,  all,  of 
course,  respectively  junior  in  their  lien,  but  they  have 
passed  out  of  favor  to  an  extent  that  any  beyond  second 
are  practically  unknown  now.  Complete  absence  of  re- 
presentative physical  security  in  so  far  as  a  mortgage 
is  concerned  is  the  dominant  characteristic  of  the  deben- 


Classification  31 

ture  bond.     In  reality  it  differs  little  from  a  promissory 
note  being  generally  a    simple   promise    to   pay.     In 

effect  it  is  a  very  formal  note.     It  is  generally 

J     Debenture 

a  last  claim  on  the  properties  of  the  issu- 
ing company  and  is  inferior  to  all  other  of  its  bonds. 
Obviously  none  but  corporations  of  a  high  character 
and  whose  status  is  well  defined  can  successfully  issue 
this  type.  The  term  debenture  means  debt.  Under 
this  broad  interpretation  other  obligations  are  some- 
times so  called.  Principal  among  these  are  some  bonds 
issued  by  municipalities  in  Canada.  The  debenture  is 
an  idea  characteristically  English  and  one  that  may 
be  said  to  have  been  borrowed  by  some  of  the  larger 
and  stronger  corporations  of  this  country.  A  few 
railroad  corporations  have  outstanding  what  are  known 
as  "plain"  bonds  which  are  nothing  more  or  less  than 
debentures  having  likewise  no  mortgage  security. 

From  the  foregoing,  a  relationship,  more  or  less  near, 
between  the  character  of  a  bond  and  its  name,  is 
evident.  With  some  it  is  very  close,  the  name  indicat- 
ing clearly  the  nature  of  the  obligation ;  with  others  but 
vaguely  explanatory,  conveying  only  a  meagre  idea  of 
its  nature.  At  best  a  name  is  no  more  than  a  descrip- 
tive term  or  combination  of  terms  qualifying  each  / 
other,  any  one  of  which  may  represent  the  chief  feature 
of  a  bond.  With  accumulating  issues  on  a  property 
it  is  often  difficult  to  name  suitably  a  new  one  so  as 
to  make  it  fully  expressive ;  hence  the  necessity  of  long, 
often  confusing  and  sometimes  apparently  conflicting 
combinations.  The  name,  however,  is  not  always  the 
result  of  circumstances  of  this  nature.  It  would  not 
be  without  precedent  should  sinister  motives  actuate  a 
company  in  describing  a  proposed  bond  issue.  Certain 
terms  of  course  are  technically  admissible  in  names; 


32  Investment  Bonds 

yet  this  has  sometimes  been  presumed  upon  to  an  extent 
actually  misleading.  While  some  names  are  indeed 
adequately  descriptive,  mere  titles,  often  signifying 
only  part,  mean  little  from  the  viewpoint  of  investment. 
Every  issue  must  be  studied  carefully  and  examined  on 
its  own  merits. 

In  the  title  of  almost  every  bond  one  term  at  least  is 
an  index  of  its  nature.  For  example,  names  like  assess- 
ment, tax  relief,  and  the  like  instantly  indicate  municipal 
issues;  we  know  at  a  glance  the  class  of  the  issuing 
corporation.  The  relative  position  of  a  bond  issue  is 
a  matter  of  vital  importance.  To  some  extent  this  is 
shown  in  names.  Again,  the  specific  purpose  of  issue 
is  many  times  embodied  in  the  name;  special  features 
and  unusual  privileges  are  betokened  and  nearly 
always  there  is  evidence  of  the  presence  and  nature  or 
the  absence  of  security. 

The  subjoined  classification,  number  two,  proceeding 
along  this  line  shows  in  a  general  way  the  bonds  whose 
names  indicate  their  function,  security  or  its  absence, 
security  and  function,  maturity  conditions  and  condi- 
tions existing  during  life.  The  other  tabular  form 
follows  the  text  early  in  this  chapter,  beginning  with 
the  great  classes  of  corporations,  considering  the 
various  kinds  of  corporations  in  each  class  and  the 
different  types  of  bonds  issued  by  each.  Both  these 
classifications  admit  of  many  variations,  but  in  the 
main  they  present  the  numerous  issues  corresponding, 
closely  to  common  practice.  Having  considered  the 
component  terms  of  names,  it  is  interesting  to  note  the 
variety  of  combinations  wrought  out: 

First  Lien  and  Collateral  Trust 
First  Mortgage  and  Collateral  Trust 


Classification  33 

First  Consolidated  Mortgage 

First  Lien  and  Consolidated 

First  Refunding  Mortgage 

First  and  Refunding 

First  Extension  Mortgage 

First  and  Collateral 

First  Lien  and  Convertible 

First  Lien  and  Refunding 

First  General  Mortgage 

First  Mortgage  Extension 

General  First  Mortgage 

General  Refunding  Mortgage 

General  Lien  Railway  and  Land  Grant 

General  Second  Mortgage 

General  Third  Mortgage 

General  Lien  Divisional  First  Mortgage 

General  and  Refunding  Mortgage 

General  Consolidated  and  First  Mortgage 

Railroad  and  Land  Grant  General  First  Mortgage 

Prior  Lien  Railway  and  Land  Grant 

Refunding  and  Extension 

Collateral  Trust  and  First  Lien 

Consolidated  First  and  Collateral  Trust 

Refunding  and  Improvement 

Consolidated  First  and  Extension 


34 


Investment  Bonds 


PUBLIC 


QUASI-PUBLIC 


Railroad 


Public  Service 


Traction 


PRIVATE 


f  Refunding 

•j  Sinking  Fund 

I  Improvement,  etc. 


Purchase  Money 

Refunding 

Improvement 

Extension 

Construction 

Adjustment 

Unified 

Reorganization  Lien 

Consolidated  Mortgage 

ist,  and,  3rd,  Mortgage 

General  Mortgage 

Divisional 

Collateral  Trust 

Debenture 

Sinking  Fund 

Income 

Terminal 

Land  Grant 

Real  Estate 

Prior  Lien 

Joint 

Car  Trust 

Irredeemable 

Assented  Income 

Annuity 

Convertible 

Participating 

Profit  Sharing 

Debenture 

Construction 

Consolidated  Mortgage 

ist  Mortgage 

General  Mortgage 

Collateral  Trust 

Income 

Equipment 

Sinking  Fund 

Convertible 

Founders 

Real  Estate 


Classification 


35 


FUNCTION 


SECURITY 

(as  to  principal  or  interest 
or  both) 


SECURITY  AND  FUNCTION 


MATURITY  CONDITIONS 


CONDITIONS  DURING  LIFE 


No.  2. 


"  Purchase  Money 

Refunding 

Improvement 

Extension 

Construction 

Adjustment 

Unified 

Reorganization  Lien 

Consolidated  Mortgage 
L  Subsidy 

r  ist  Mortgage 
and  Mortgage 
rrd  Mortgage 
General  Mortgage 
Divisional 

Guaranteed  or  Endorsed 
Collateral  Trust 
Debenture 
Income 
Terminal 
Land  Grant 
Real  Estate 
Prior  Lien 
Joint 

( Car  Trust 
(  Equipment 


C  Redeemable 
Irredeemable 

I  Profit  Sharing 

j  Non-Exempt 
Assented  Income 

(^  Annuity 

f  Convertible 
J  Stamped 
"}  Exempt 
'  Participating 


CHAPTER  III. 

DENOMINATIONS. 

THE  range  of  bond  denominations  is  surprisingly 
wide.  Since  the  average  American  investor  carries 
in  his  portfolio  denominations  more  or  less  standard 
in  amount,  doubtless  comparatively  few  are  aware 
that  obligations  of  this  nature  may  be  purchased  in 
units  so  small  as  to  be  within  the  resources  of  even  the 
very  small  investor.  General  public  records  in  the 
financial  pages  of  the  newspapers  impart  little  or  no 
knowledge  on  this  point.  The  market  quotations 
there  recorded  are  as  of  a  standard  amount  whatever 
the  denominations  may  be. 

The  greatest  number  of  denominations  with  the 
widest  variations  in  amounts  are  found  in  Government 
bonds,  both  home  and  foreign.  Take  the  funded 
obligations  of  the  United  States:  the  four  per  cent, 
loan  of  1907  was  issued  in  denominations  of  $50,  $100, 
$500,  $1000,  $5000,  $10,000,  $20,000,  $50,000;  the 
four  per  cent,  loan  of  1925  is  in  similar  denominations 
except  that  the  highest  is  $10,000;  the  three  per  cent, 
loan  of  1908-1918  is  similar  to  that  of  1925  except  that 
the  denomination  of  $50  is  omitted  and  one  of  $20  sub- 
stituted from  which  it  is  seen  that  our  Government 
issues  its  obligations  ranging  from  the  popular  price 
of  $20  up  to  the  exclusive  figure  of  $50,000  per  bond. 
In  fact,  upon  special  request,  and  if  believed  expedient, 

36 


Denominations  37 

the  Treasury  authorities  would  reach  up  to  even  higher 
denominations. 

Denomination  affects  form  and  vice  versa — not  all 
these  denominations  are  in  either  form;  i.  e.y  coupon  or 
registered.  Coupon  bonds  are  seldom  for  more  than 
$1000  while  those  that  require  registration  range  above 
that  to  the  highest  amounts.  The  smallest  denomina- 
tions of  the  two  forms,  however,  are  usually  identical. 
In  subscribing  for  United  States  Government  bonds, 
an  investor  or  purchaser  has  considerable  latitude. 
Unrestricted  to  one  form  or  denomination,  he  may 
generally  take  up  his  allotment  wholly  in  coupon  or 
registered  form  or  partially  in  either,  and  in  such  de- 
nominations as  he  designates. 

Of  foreign  governments  France  undoubtedly  mani- 
fests the  greatest  disposition  to  cut  up  its  debt  into 
small  pieces.  That  government  has  three  prominent 
loans  outstanding,  the  three  per  cent,  perpetual  rentes, 
an  issue  of  three  and  one  half  per  cent,  rentes  and 
another  of  three  per  cent,  redeemable  rentes.  The  first 
two  may  be  inscribed  in  any  amount  with  a  minimum  of 
three  francs  and  two  francs  respectively;  the  three  per 
cent,  redeemable  rentes  can  only  be  taken  in  amounts 
of  fifteen  francs  and  multiples  thereof.  These  bonds 
when  payable  to  bearer  with  coupons  can  be  had  in  the 
following  amounts  of  rente;  three  per  cents.,  3,  4,  5,  6, 
7,  8,  9,  10,  20,  30,  50,  100,  200,  300,  500,  1000,  1500, 
3000  francs;  the  three  and  one  half  per  cents.,  2,  3,  4,  5, 
6,  7,  8,  9,  10,  20,  30,  50,  100,  200,  300,  500,  1000,  1500, 
3000  francs;  three  per  cent,  redeemables,  15, 30,  60, 150, 
300,  600,  1500,  3000  francs.  Here  wTe  have  a  unit  so 
absurdly  low  as  approximately  4oc. — 2  francs,  a  franc 
being  equivalent  to  IQ^C.  Germany  also  has  three 
principal  loans  but  the  minimum  is  far  higher  than  in 


38  Investment  Bonds 

France,  being  two  hundred  marks.  A  mark  being 
equivalent  to  240.  makes  the  lowest  amount  for  nearly 
$50.  Next  above  200  marks  is  500  and  then  1000, 
2000,  5000,  and  10,000  each. 

Variations  in  denominations  of  municipal  bonds  are 
somewhat  limited  in  comparison  with  the  issues  of 
governments.  The  same  general  principle  holds, 
however.  Where  there  is  a  great  diversity  in  Govern- 
ment issues,  a  corresponding  diversity  in  municipal 
issues  as  compared  with  "similar  obligations  in  other 
lands  is  found;  but  generally  speaking,  the  high  figures 
are  never  reached  in  municipal  bonds.  In  illustration 
of  this,  take  a  recent  issue  by  the  Province  of  Ontario, 
Canada;  to  float  a  loan  of  $3,000,000,  denominations 
were  fixed  at  $200,  $500  and  $1000.  Or  take  the 
public  debt  of  Philadelphia,  Pa. ;  this  is  put  out  in  pieces 
of  $25,  $50,  $100  and  $1000,  or  again,  merely  for  ex- 
ample, take  a  late  issue  by  a  county  in  one  of  the  west- 
ern States;  in  that  instance  the  denominations  were  $100, 
$200,  $300,  $400,  and  $500.  So  it  is  quite  generally 
with  municipalities — their  obligations  may  be  issued  for 
small  amounts  but  the  highest  rarely,  if  ever,  exceeds 
$1000.  The  examples  cited  are  fairly  representative. 

With  other  corporations  such  as  steam  and  electric 
railroads,  manufacturing  concerns,  etc.,  a  uniform 
practice  holds ;  deviations  from  this  are  so  few  as  to  be 
negligible.  Their  bonds  are  universally  in  units  of 
$1000  and  never  issued  in  such  low  denominations  as  are 
sometimes  put  out  by  governments  and  municipalities. 
Beyond  $1000  and  in  multiples  of  that  amount,  they 
range  to  about  $25,000  but  this  high  figure  is  excep- 
tional: below  $1000  they  may  be  found  in  $500  and 
$100  amounts  but,  to  repeat,  the  general  practice  is 
to  issue  the  $1000  unit. 


Denominations  39 

It  will  be  observed  therefore,  that  most  bonds  are 
issued  for  a  round  sum,  generally  a  convenient  multiple ; 
the  exceptions  are  anomalies  and  are  correspondingly 
affected  for  ill. 

In  so  far  as  foreign  government  bonds  are  considered, 
it  may  be  said  there  is  no  standard.  English  Consols, 
French  Rentes,  the  German  Mark  obligations  and 
many  others  are  written  up  in  such  widely  varying 
amounts  that  there  is  really  no  well  defined  unit  in 
any  of  those  countries.  In  the  United  States  it  is 
different.  Notwithstanding  low  denominations  put 
out  by  the  Government  and  municipalities,  there  is  a 
generally  accepted  standard  which  is  $1000.  Indeed 
a  great  portion  of  the  Government  and  municipal  loans 
are  covered  by  denominations  of  this  amount.  Since 
the  general  practice  among  other  corporations  is  to 
issue  their  obligations  with  $1000  as  the  unit,  it 
naturally  becomes  a  standard  for  them  too.  Yet 
market  quotations  are  apt  to  mislead  the  untutored 
into  a  false  conclusion  that  bonds  are  issued  solely 
in  denomination  of  $100.  This  method  of  quoting 
however,  is  to  give  a  basis  in  terms  of  which  all  values 
are  readily  computed. 

Casually  considered,  the  amounts  of  bond  denomina- 
tions might  appear  to  be  largely  arbitrary.  The  facts 
are  otherwise.  A  number  of  reasons  exist  for  the  issu- 
ance of  bonds  as  now  practised.  Denominations  of 
every  bond  issue,  be  it  Government,  State,  Municipal, 
or  otherwise,  are  fixed,  not  by  whim  or  fancy  of  the 
officials  conducting  it,  but  by  some  well-defined  influ- 
ences or  laws  or  both.  Determination  of  denominations 
may  be  directly  by  some  individual,  but  indirectly  it 
is  in  accord  with  certain  conditions.  The  Secretary  of 
the  Treasury,  the  municipal  officer  in  charge,  or  the 


40  Investment  Bonds 

proper  officials  of  a  railroad  or  manufacturing  company 
must  set  the  denominations  mindful  of  a  number  of 
conditions.  Market,  with  all  that  implies,  is  the  chief 
determining  factor.  Generally  speaking,  the  market 
is  the  investing  public,  and  to  be  successful  a  bond  issue 
must  be  adapted  in  every  particular  to  the  nature  of  the 
demand.  Notice  the  position  of  France;  a  nation  of 
savers,  thousands  of  them  very  small,  the  Government 
security  of  a  few  francs  finds  a  ready  market.  It  is  im- 
possible to  get  the  average  French  investor  to  consider  a 
$500  bond,  much  less  one  for  $1000,  the  two  denomina- 
tions much  used  in  the  United  States,  inasmuch  as  the 
average  investment  in  France  is  1000  francs  or  $200. 
So  in  England  and  the  United  States,  there  is  a  measure 
of  popular  demand  for  Government  bonds,  conse- 
quently low  denominations.  Municipal  bonds  find  a 
market  essentially  local  while  other  corporations  appeal 
to  still  another  type  of  investors  more  widely  scattered. 
Suitability  to  investors,  therefore,  is  of  prime  im- 
portance in  choosing  denominations.  Inasmuch  as  the 
types  of  investors  in  Government,  municipal,  and  other 
corporation  bonds  are  more  or  less  distinct,  the  range 
of  units  of  each  kind  is  in  conformity.  Generally 
speaking,  the  more  popular  a  loan,  the  more  diverse 
are  its  denominations  and  the  lower  the  amounts. 
Earlier  it  is  stated  that  the  form  of  bond  affects  the 
denomination.  This  is  more  so  with  Government  bonds 
than  others.  In  all  cases,  nevertheless,  where  they 
are  coupon  bonds,  negotiation  is  quickly  accomplished, 
while  the  registered  form  requires  some  formalities. 
Obviously  those  bonds  that  are  to  pass  through  the 
channels  of  exchange  most  frequently  would  be  in  a 
form  to  facilitate  the  process.  Because  of  the  com- 
parative inactivity  of  the  registered  form,  it  can  well 


Denominations  41 

be  issued  in  large  denominations.  In  the  face  of  such 
facts,  it  is  apparent  that  the  size  of  an  issue,  its  nature 
and  its  purpose,  are  all  factors  affecting,  and  that  an 
arbitrary  unit  is  impracticable.  Relatively  unim- 
portant, yet  of  some  account,  is  the  expense  attached 
to  a  fine  division  of  an  issue  and  the  matter  of  con- 
venience in  handling.  The  Government  may  find  it 
expedient  to  issue  $20  bonds  but  also  costly.  Other 
corporations  do  not  adopt  the  same  course,  nor  do  they 
find  it  necessary. 

Public  corporation  bonds  alone  are  affected  by  statu- 
tory provisions  as  to  their  denominations;  that  is  to 
say,  by  some  ordinance,  rule,  or  governing  regulation 
aside,  perhaps,  from  some  very  general  legislative 
enactment.  The  diversity  of  circumstances  attending 
bond  issues  makes  it  entirely  impracticable  to  frame 
specific  laws  with  respect  to  this  phase  of  the  matter. 
There  may  be  isolated  instances  where  a  statute  gov- 
erns the  action  of  a  quasi-public  corporation  in  the 
matter  of  fixing  denominations  of  its  bonds,  but  they 
are  exceptions  to  the  rule.  The  provisions  applying 
to  the  paper  of  public  corporations  are  generally  em- 
bodied in  the  act  authorizing  the  issue,  at  least  in  the 
case  of  Government  and  State  bonds.  Among  munici- 
pals, the  empowering  ordinance  specifies  what  shall 
be  done,  but  often  the  charter  of  a  city  contains  the 
governing  regulations.  In  New  York  City,  for  in- 
stance, par  value  is  provided  for  in  this  manner. 
Under  charter  provisions  the  city  may  issue  registered 
bonds  in  denominations  of  ten  dollars  or  any  multiple 
thereof.  Yet  wherever  there  are  directions  pertaining 
to  this  matter,  their  limitations  are  practically  nil. 
Were  they  absent,  most  officials  would  of  necessity  act 
quite  within  their  spirit.  Illustrating  the  latitude 


42  Investment  Bonds 

allowed  by  such  provisions,  note  the  reading  of  most 
of  the  acts  authorizing  a  Government  issue,— "The 
act  of  (date)  authorizes  the  Secretary  of  the  Treasury 
to  borrow  on  the  credit  of  the  United  States,  from  time 
to  time,  as  the  proceeds  may  be  required,  to  defray 
expenses  authorized  on  account  of  (purpose)  the  sum 
of  (amount)  or  so  much  thereof  as  may  be  necessary 
and  to  prepare  and  issue  therefor  coupon  or  registered 
bonds  of  the  United  States  in  such  form  as  he  may 
prescribe,  and  in  denominations  of  twenty  dollars  or 
some  multiple  of  that  sum";  which,  of  course,  gives 
the  Secretary  wide  discretionary  powers  respecting 
this  matter.  Such  an  act  is  a  guide  rather  than  a 
restraint  to  a  prescribed  course. 


CHAPTER  IV. 

PROCESSES  OF  ISSUE  AND  NEGOTIATION. 

A  DESCRIPTION  of  these  operations  in  great  detail 
would  suffice  for  a  small  volume,  so  diverse  are  the 
methods  and  so  ramified  the  processes.  Details  of  the 
work  vary  greatly,  but  underlying  all  are  a  few  general 
principles. 

Assuming  the  necessity  or  expediency  of  bond  issue 
the  first  step  of  the  process  naturally  becomes  the  sub- 
ject of  inquiry.  By  whom  is  it  authorized?  That 
depends  upon  the  nature  of  the  corporation.  Govern- 
ment bonds  are  issued  under  authority  granted  by 
Congress,  in  whom  is  vested  the  debt-creating  power, 
and  State  bonds  by  act  of  the  legislatures  of  the  several 
States.  The  authorization  of  municipal  bonds  is  not 
a  uniform  process,  varying  in  different  States  and  with 
conditions.  In  its  final  analysis,  the  authority  to  issue 
resides  in  the  State  legislature;  its  immediate  exercise 
is  by  some  local  body  such  as  a  Council,  Board  of 
Trustees,  etc.  Frequently,  however,  a  municipality  is 
prohibited  from  bond  issue  save  by  specific  legislative 
permit  for  each  issue,  and  again  this  permit  must  be 
accompanied  by  favorable  vote  of  the  people.  Still 
again  it  is  but  the  people  and  the  local  body,  while  in 
cities,  where  voting  on  such  propositions  is  impracti- 
cable, charter  provisions  grant  the  necessary  authority. 

43 


44  Investment  Bonds 

With  other  corporations  it  is  uniformly  the  preroga- 
tive of  the  stockholders.  A  unanimous  vote  of  the 
stockholders  is  rarely  necessary.  Usually  some  per- 
centage such  as  fifty-one,  sixty -six  and  two  thirds  or 
seventy -five  per  cent,  is  sufficient  to  decide.  Back  of 
the  stockholders  is  the  charter  which  empowers  them 
to  borrow  money  by  the  issue  of  bonds.  Beyond  the 
stockholders  are  the  directors.  With  the  stock- 
holders' authority  the  directors,  by  resolution,  carry- 
out  their  wishes.  Generally  the  initiative  is  taken  by 
the  directors.  In  closer  touch  with  the  corporation, 
they  know  its  needs  better.  Accordingly  a  resolution 
is  drawn  up  and  presented  to  the  stockholders  for  their 
ratification.  Supplemental  to  corporate  action  the 
railways  within  the  borders  of  certain  States  must  se- 
cure the  approval  of  a  railroad  commission  should  they 
desire  to  issue  bonds.  Particularly  is  this  the  case 
with  street  railways. 

In  many  States,  not  alone  railways  but  all  corpora- 
tions issuing  bonds  must  furnish  the  Secretary  of  State 
or  other  officer  with  a  certified  statement  or  letter 
giving  full  particulars  of  the  issue,  which  statement 
generally  includes  date  of  issue,  number  of  bonds, 
amount  of  issue,  when  and  where  payable. 

The  next  step  is  preparation  of  the  instrument.  A 
draft  of  the  text,  made  under  guidance  of  counsel,  is 
handed  to  the  engravers,  accompanied  by  a  general  de- 
scription as  to  the  appearance  of  the  bond.  Proofs  are  ' 
made  and  submitted  for  any  changes  artistic  or  legal. 
When  the  final  form  is  determined  it  is  returned  to  the 
engravers  and  the  work  executed  according  to  agree- 
ment. The  work  completed,  the  bonds  are  counted 
and  recounted,  checked  and  verified  and  duly  handed 
to  the  issuing  company.  There  is  a  repetition  of 


Processes  of  Issue  and  Negotiation      45 

checking  and  counting  by  the  company  and  whatever 
official  signatures  are  necessary  are  affixed  and  the  seal 
of  the  company  placed  on  each  bond. 

So  far  the  process  is  essentially  uniform  be  the  issue 
Government,  municipal,  or  otherwise.  Here  the  paths 
diverge,  according  to  the  corporation  and  conditions. 
Even  separate  issues  by  the  same  corporation  may  be 
put  out  in  different  ways  as  to  details. 

Before  a  great  many  bonds,  other  than  Government 
and  municipal,  pass  to  the  first  holder,  they  are  almost 
invariably  certified  by  a  trust  company.  Where  a 
mortgage  indenture  is  given  it  is  usually  held  by  a  trust  ' 
company.  Naturally  the  bonds  under  that  mortgage  >^ 
would  be  certified  by  the  same  company.  This  trustee- 
ship of  the  mortgage  gives  prestige  to  the  transaction 
and  the  certification  forms  a  protection  to  the  pur- 
chaser of  the  bonds.  This  certification,  however,  is 
only  as  to  the  genuineness  of  the  issue  and  that  it  floes  V 
not  exceed  the  amount  prescribed.  Its  absence  has 
been  the  opportunity  many  times  in  the  past  for  over 
and  fraudulent  issue.  Especially  was  this  true  of 
municipal  bonds.  Even  now,  without  this  safeguard, 
losses  may  be  occasioned  by  error  alone.  Because  of 
the  frequent  changes,  many  incumbents  of  public  office 
are  apt  to  have  but  insufficient  experience  along  these 
lines. 

Some  years  ago  the  New  York  Stock  Exchange, 
recognizing  the  necessity,  made  rigid  requirements  as 
to  certification.  Since  then,  corporations,  even  though 
their  bonds  do  not  pass  through  the  Exchange,  en- 
deavor to  conform  to  these  requirements. 

The  business  of  thus  certifying  bonds  has  proved 
lucrative  for  many  trust  companies,  their  charges 
running  from  twenty-five  cents  up,  but  seldom  higher 


46  Investment  Bonds 

than  fifty  cents  per  bond.  On  a  few  small  issues  the 
charge  may  be  somewhat  higher.  Obviously,  the  fee 
under  a  mortgage  of  say  one  hundred  millions  of  dollars 
is  no  inconsiderable  item.  This  form  of  compensation 
is  said  to  have  netted  a  large  trust  company  in  New 
York  City,  in  a  recent  year,  not  less  than  $175,000. 

Being  duly  certified,  the  bonds  are  usually  returned 
to  the  issuing  corporation  for  disposition. 

The  method  employed  by  the  Government  in  dis- 
posing of  its  bond  issues  is  public  sale.  Some  years 
ago  a  few  issues  were  taken  entirely  by  syndicates, 
but  this  course  has  been  abandoned.  Obedient  to 
the  law,  the  Secretary  of  the  Treasury  prepares  a  cir- 
cular inviting  subscriptions,  which  contains  a  full 
description  of  the  issue  and  the  terms  under  which 
the  bids  will  be  awarded.  It  also  contains  a  reprint 
of  the  text  of  the  act  authorizing  the  issue.  In  this  way 
every  loan  is  made  popular.  In  fact  the  law  provides 
that  all  citizens  of  the  United  States  shall  have  equal 
opportunity  to  subscribe  therefor  and  the  Treasury 
Department  seeks,  by  every  means,  to  extend  the 
opportunity  for  such  subscription  to  all  the  people. 
In  the  case  of  the  Spanish  war  loan  every  newspaper 
in  the  United  States  was  supplied  with  interesting 
and  instructive  information  relative  to  the  issue, 
which,  with  few  exceptions,  was  patriotically  displayed 
free  of  charge. 

Blank  forms  for  subscriptions,  with  circulars  of 
information,  were  supplied  and  a  period  of  thirty- 
one  days  allowed  for  receipt  of  subscriptions.  The 
Secretary's  course  was  unusual  in  this  case.  Ordi- 
narily circulars  are  sent  broadcast  and  advertisements 
inserted  in  financial  papers,  but  no  such  efforts  are 
put  forth  as  at  that  time. 


Processes  of  Issue  and  Negotiation       47 

As  far  back  as  1776  this  was  essentially  the  method 
pursued.  To  float  loans  during  that  period  loan  offices 
were  established  in  each  State;  lenders  received  in- 
dented certificates  corresponding  to  our  modern  coupon 
bonds. 

Naturally  the  response  to  such  popular  invitations 
is  hearty. 

In  many  respects  the  popular  loan  of  1898  was  the 
most  extraordinary  bond  offering  attempted  in  this 
country.  The  Treasury  was  literally  flooded  with 
applications  from  325,000  genuine  bidders  and  hosts 
of  fraudulent  ones.  This  $200,000,000  issue  was 
sold  at  par,  232,224  subscriptions  for  $500  or  less 
being  received  by  the  Government  through  22,000 
post-offices,  the  banks,  and  express  companies.  The 
Treasury  had  to  add  nearly  six  hundred  employees  to 
its  working  staff  in  order  to  properly  tabulate  the  bids 
and  attend  to  the  details  of  the  offering,  the  expense 
of  which  amounted  to  $292,959.  Within  five  months, 
$77,361,000  of  the  bonds  originally  allotted  to  116,000 
subscribers  were  concentrated  in  the  hands  of  1001 
owners,  which  shows  that  the  original  holders  soon 
sold  their  allotments.  It  was,  however,  a  great  popular 
success. 

The  Government  received  4635  bids  for  the  $100,- 
000,000  4  per  cent,  loan  of  February,  1896,  and  the 
$30,000,000  issue  of  Panama  2  per  cent,  bonds  of 
1906  brought  1500  bids. 

The  question  of  cash  deposit,  which  is  within  the  dis- 
cretion of  the  Secretary,  affects  the  bidding  on  Govern- 
ment loans.  As  an  evidence  of  good  faith  a  cash  deposit 
is  usually  required  with  subscriptions,  but  occasionally 
part  payment  may  not  be  required  until  a  certain  date 
after  subscribing.  Again  the  deposit  may  be  required 


48  Investment  Bonds 

on  notice  of  allotment.  The  stipulation  as  to  a  cash 
deposit  is  omitted  only  in  times  when  the  money 
market  might  become  disturbed  if  this  were  required 
of  bidders.  The  Panama  issue,  for  instance,  was  over- 
subscribed more  than  fifteen  times.  Had  only  a  ten 
per  cent,  deposit  been  required,  nearly  $50,000,000 
would  have  been  tied  up  for  a  time.  On  the  other 
hand,  it  is  the  only  way  to  discourage  the  practice  of 
"straw"  or  speculative  bidding. 

A  short  time  after  bids  are  opened,  a  list  of  awards  is 
published.  When  payments  are  required  they  may  usu- 
ally be  made  at  some  designated  sub-treasury  most  con- 
venient. The  delivery  of  the  bonds  is  accomplished 
in  numerous  ways.  Sending  direct  to  the  purchaser 
by  mail  or  express,  or  through  a  sub-treasury,  are 
among  them.  This,  however,  is  largely  in  accord  with 
the  purchaser's  convenience  and  any  reasonable 
request  as  to  delivery  is  generally  honored  by  the 
Secretary.  The  course  of  the  Government  is  prac- 
tically the  same  in  disposing  of  all  its  bond  issues. 

Foreign  governments,  in  floating  loans  abroad,  usu- 
ally pursue  a  course  similar  to  that  of  the  large  private 
corporations  of  this  country  in  placing  their  securities 
with  large  bankers  for  distribution.  The  bankers  re- 
ceive subscriptions,  much  in  the  same  manner  as  our 
Government,  make  allotments  by  letter  at  their  dis- 
cretion, exchange  these  allotment  letters  for  temporary 
certificates  upon  payment  of  final  instalment,  and  the 
bonds  are  delivered  in  exchange  for  the  temporary 
certificates  as  soon  as  practicable.  These  bankers  are 
usually  the  most  prominent  in  the  financial  centres  of 
various  countries.  The  issuing  nation  allots  a  certain 
amount  to  each  group  of  bankers. 

The  individual  States  of  this  country  follow  largely 


Processes  of  Issue  and  Negotiation       49 

the  methods  of  the  Government.  The  laws  generally 
compel  this.  Public  subscription  is  universal,  sealed 
proposals  being  received  at  the  office  of  the  State 
Comptroller  until  a  certain  date  for  whole  or  part 
of  the  issue  and  awards  being  made  to  the  highest 
bidder. 

Municipalities  vary  in  their  procedure;  exigencies 
of  circumstances  and  the  judgment  of  officials  in  charge 
often  figure  prominently.  There  are,  however,  certain 
legal  requirements  which  must  be  observed,  such  as 
advertising  the  issue  in  the  papers  of  the  county  in 
which  the  municipality  is  located.  Should  the  market 
be  favorable  an  entire  issue  may  be  sold  over  the  counter 
of  the  Treasurer's  office  direct  to  investors.  Again  it 
may  go  in  large  blocks  to  bankers  and  brokers.  Still 
another  method  of  disposing  of  considerable  amounts 
is  to  offer  them  to  the  Sinking  Fund  Commissioners  of 
the  same  municipality.  The  necessity  of  purchasing 
large  amounts  of  securities  for  sinking  funds  creates 
an  outlet  for  goodly  portions  which  might  otherwise 
meet  an  unfavorable  market. 

Bidding  for  bonds  concerns  only  corporations  of  the 
classes  just  mentioned.  The  operation  is  interesting. 
Briefly  stated,  it  calls  for  bids  in  a  sealed  envelope, 
enclosed  in  a  properly  addressed  envelope.  If  a  cash 
deposit  is  required,  it  may  be  from  two  per  cent,  up 
to  any  per  cent,  of  the  par  value;  other  times  it  may 
be  a  specified  amount.  In  successful  bidding  this 
amount  is  applied  toward  payment,  otherwise  it  is 
returned  within  two  or  three  days  of  awards.  Failure 
to  take  up  a  bid  forfeits  the  deposit.  The  bids  may  be 
for  "all  or  none,"  "all  or  any  part,"  of  the  whole,  "all 
or  any  part"  of  a  specified  amount,  etc.  The  price 
offered  may  be  a  certain  figure  or  different  figures  for 


50  Investment  Bonds 

different  amounts.  Following  is  a  bid  that  was  made 
for  some  New  York  City  bonds  which  is  illustrative 
of  the  method :  * '  1 01 . 13  5  for  all  or  any  part  of  $5 ,000,000 : 
each  for  $100,000  or  any  part  of  that  amount;  100.265, 
100.387,  100.527,  100.637,  100.887;  100.777  for  $1,500,- 
ooo  or  any  part  thereof."  Invariably  the  right  to 
reject  bids  is  reserved. 

Corporations  such  as  railways,  manufacturing  com- 
panies, etc.,  issue  their  bonds  in  ways  entirely  affected 
by  conditions.  An  issue  may  be  put  out  all  at  once,  or 
in  amounts  according  to  some  special  conditions,  or  as 
the  work  for  which  they  are  issued  progresses,  etc.  No 
semblance  of  uniformity  exists.  Companies  are  large, 
medium  sized,  and  small  and  their  methods  corre- 
spondingly varied.  They  may  advertise  for  bids,  as  do 
municipalities;  turn  them  over  directly  to  a  syndicate; 
sell  to  some  large  banking  house,  or,  as  is  frequently 
done,  offer  them  first  to  the  stockholders  of  the  company 
and  syndicate  or  sell  to  bankers  those  not  taken  upon 
this  offering.  In  refunding  operations  it  is  largely  a 
matter  of  exchanging  the  old  for  the  new. 

Large  issues  are  usually  sold  in  their  entirety  to  a 
strong  banking  house.  Under  favorable  conditions, 
a  better  price  would  be  realized  by  public  sale,  but  the 
necessity  for  money  often  arises  when  conditions  are 
otherwise.  The  services  of  a  banking  firm  in  marketing 
bonds  may  be  so  valuable  that  in  the  long  run  a  com- 
pany may  realize  more  for  its  securities  than  if  it 
attempted  to  sell  them  without  the  bankers'  aid. 
Companies,  therefore,  in  many  instances,  enter  into 
a  contract  giving  a  firm  the  right  to  take  over  all  of 
their  bond  issues.  The  advantages  of  this  course  are 
manifold.  Large  banking  houses  are  in  close  touch 
with  the  investing  public,  they  have  a  finely  organized 


Processes  of  Issue  and  Negotiation        51 

equipment  for  distributing  such  securities,  their  ex- 
perience in  making  bond  offerings  attractive  is  wide 
and  they  have  the  skill  and  facilities  for  handling  the 
market.  Moreover,  a  bond  issue  put  into  the  market 
through  reputable  bankers  carries  with  it  the  recom-' 
mendations  of  experts  whose  investigations  of  every 
phase  of  the  situation  have  been  thorough.  When  a 
company  wishes  to  dispose  of  an  issue  its  bankers  are 
usually  consulted,  and  their  judgments  and  suggestions 
embodied  so  as  to  best  adapt  it  to  the  market  and 
conditions. 

If  an  issue  be  of  considerable  size,  the  purchasing 
banker  will  wish  to  insure  it,  so  to  speak,  and  accord- 
ingly proceed  to  form  an  underwriting  syndicate. 

No  banker,  however  large  his  capital,  cares  to  assume 
the  entire  risk  nor  tie  up  so  much  capital  in  one  security. 
Conditions  may  arise  making  it  impossible  to  market 
the  issue,  for  the  time  being,  hence  the  underwriting 
which  is  virtually  insurance. 

Underwriting  of  to-day  is  somewhat  different  from 
the  original  practice.  Originally  the  underwriter  was 
under  obligation  to  apply  on  the  public  issue  for  such 
a  proportion  of  the  securities  offered  as  the  banker 
might  require  him  to  apply  for  within  a  certain  limit. 
Each  underwriter  agreed  for  a  certain  amount  on 
which  he  would  receive  a  commission  and  he  would 
have  to  buy  his  proportion  of  those  remaining  unsub- 
scribed for  by  the  investing  public.  Now,  it  is  cus- 
tomary to  form  an  underwriting  syndicate  which,  in 
reality,  purchases  the  securities  from  the  banker.  He 
it  is,  however,  who  offers  them  to  the  public,  for 
account  of  the  syndicate,  and  whatever  securities  re- 
main unsold  on  the  public  issue  syndicate  subscribers 
retain.  Strictly  speaking  this  is  not  underwriting, 


52  Investment  Bonds 

but  this  term,  as  now  understood,  means  not  only 
underwriting  but  indicates  that  a  syndicate  exists. 
The  earlier  method  might  aptly  be  termed  conditional 
and  the  later  absolute  underwriting. 

The  prominence  of  syndicates  in  the  distribution 
of  issues  of  bonds  warrants  a  description  of  their  forma- 
tion, operation,  dissolution,  etc.  Their  members  may 
be  individuals,  banks,  bankers,  brokers,  trust  com- 
panies, etc.  Primarily  they  are  formed  to  reduce  the 
liability  of  the  bankers  taking  the  bonds  originally, 
and  to  effect  a  thorough  and  expeditious  distribution 
of  the  securities. 

When  about  to  take  over  an  issue  of  securities  the 
banker  sends  letters  to  institutions  and  persons  as- 
sociated with  him,  stating  quite  fully  the  nature  of  the 
issue  and  inquiring  whether  they  desire  to  enter  the 
prospective  syndicate,  or  informing  them  a  certain 
interest  has  been  reserved  and  desiring  a  reply  as  to 
acceptance. 

If  the  syndicate  be  small,  its  arrangements  could 
be  made  verbally,  which  is  sometimes  done.  The 
majority  of  such  operations,  however,  are  conducted 
under  the  terms  of  a  formal  document,  an  Under- 
writing or  Syndicate  Agreement.  Each  member  signi- 
fies acceptance  by  signature  on  the  agreement,  or,  if 
this  is  not  practicable,  by  signature  on  a  copy  and  the 
banker  retains  same.  This  agreement  briefly  describes 
the  security  purchased  and  provides  that  no  subscriber 
v  shall  be  liable  for  more  than  the  amount  of  his  sub- 
scription. It  further  provides  for  the  details  of 
management  and  the  taking  up  of  the  bonds  at  a 
specified  date  and  price  unless  there  are  stipulations 
that  the  syndicate  may  be  extended  by  a  majority 
vote.  An  extension  may  run  into  years.  A  syndicate 


Processes  of  Issue  and  Negotiation       53 

which  underwrote  a  large  railroad  issue  has  just  been 
dissolved,  having  run  nine  years. 

Administration  of  a  syndicate  requires  considerable 
time  and  attention,  which  is  accomplished  by  appoint- 
ment  of  managers.  Usually  the  bankers  perform  this 
function  although  a  trust  company  may  act  in  this 
capacity,  in  which  case  it  would  attend  to  the  prospectus 
that  is  issued  and  see  that  the  securities  under  consider- 
ation were  put  into  the  market,  much  in  the  same 
manner  as  the  bankers  would  do.  The  responsibility 
of  practical  execution  of  all  work  lies  with  the  managers. 
In  fact  upon  them  depends  largely  the  completion  of 
the  whole  transaction  in  a  way  mutually  beneficial  to 
all  who  participate.  Nevertheless  it  is  generally 
understood  that  every  member  shall  assist  in  as  large 
a  measure  as  possible  in  the  distribution  of  the  se- 
curities. All  are  expected  to  do  more  than  take 
profits;  and  they  each  do  endeavor  to  get  a  number  of 
subscriptions  for  certain  amounts,  acting  essentially 
as  an  agent  for  the  benefit  of  the  whole  syndicate. 

Frequently  a  considerable  period  elapses  from  the 
time  when  the  banker  takes  the  securities  from  the 
corporation  until  members  of  the  syndicate  have 
disposed  of  their  holdings.  It  is  an  operation  which 
must  often  be  long  continued  and  may  last  anywhere  > 
from  six  months  to  two  years  and  even  longer. 

Profits  attending  syndicate  operations  vary  with 
conditions.  Instead  of  a  profit  a  misjudged  market 
may  mean  a  loss.  Except  during  the  most  adverse 
monetary  and  market  conditions  a  substantial  profit 
is  realized.  First  of  all  is  the  banker.  A  few  years 
ago  a  commission  of  five  per  cent,  was  not  uncommon ; 
the  feature  of  present  bond  offerings  is  that  these  com- 
missions are  growing  smaller  and  smaller,  two  per  cent. 


54  Investment  Bonds 

being  considered  profitable,  whereas  sometimes  it  is 
still  less. 

Syndicate  profits  are  no  less  affected  by  market  and 
other  conditions.  Should  an  issue  be  so  successful 
that  the  members  are  able  to  put  through  quick  sales 
or  even  sell  their  allotments  in  advance  of  the  under- 
writing, so  that  they  may  not  be  compelled  to  put  up 
any  money  or  buy  any  securities,  a  handsome  profit 
may  result.  Pot  instance,  the  group  of  bankers  that 
handled  the  recent  CuTmrrToanTlietted  nearly  7  per 
cent. ;  a  recent  Russian  loan  was  syndicated  at  Q5^  and 
put  out  at  99.  Large  profit,  however,  on  high  class 
securities  is  not  usual.  Securities  of  weaker  corpora- 
tions are  underwritten  with  the  full  expectation  of 
large  returns.  Syndicates  in  industrial  issues  get 
as  high  as  10  per  cent,  at  times. 

Still  another  source  of  profit  for  syndicates  is  bonuses. 
These  may  be  a  certain  percentage  of  the  amount  under- 
written, in  the  same  or  another  kind  of  security.  Or 
again  they  may  be  a  portion  of  securities  with  some 
cash.  Such  bonuses  are  considered  as  commissions. 

There  is  yet  another  way  in  which  a  syndicate  mem- 
ber may  increase  his  profits  and  that  is  by  authoriz- 
ing his  allotment  with  drawn  from  sale.  Under  these 
circumstances,  it  is  usually  taken  up  as  a  personal  in- 
vestment under  a  better  price  than  the  other  members 
obtain.  After  the  syndicate  is  closed  he  may  be  able 
to  dispose  of  his  holdings  at  a  better  figure  than 
previously. 

Marketing  of  an  entire  issue  by  the  managers,  or 
bankers,  of  course  terminates  the  syndicate.  One 
that  is  open  indefinitely  may  be  concluded  by  request 
of  a  majority  of  its  members.  Dissolution  by  limita- 
tion of  time  often  occurs. 


Processes  of  Issue  and  Negotiation        55 

During  the  life  of  the  syndicate  every  member  has  a 
right  to  examine  its  books  of  account,  but  this  is  seldom 
done.  Often,  at  the  close,  a  complete  statement  is 
sent  around  giving  full  information  as  to  the  transac- 
tions and  showing  the  pro  rata  of  profit.  Where  this 
is  not  done  full  confidence  is  reposed  in  the  bankers, 
and  their  check,  representing  the  profits  and  closing 
the  deal,  is  accepted  without  question. 

Chief  among  bond-distributing  agencies  are  private 
bankers,  the  larger  of  whom  dispose  of  their  securities  ' 
almost  entirely  through  syndicates.  An  indication 
of  the  extent  to  which  they  handle  bonds  may  be 
gathered  from  the  fact  that  it  is  roughly  estimated 
that  the  two  largest  firms  in  New  York,  besides  their 
other  business,  sell  close  to  two  millions  of  dollars  of 
bonds  each  business  day. 

Those  less  strong,  though  of  very  high  class,  have 
other  methods  besides  syndicating.  Acting  as  bankers, 
they  arrange  syndicates  and  at  times  participate  in 
them.  A  most  efficient  organization  exists  for  this 
purpose.  Like  commercial  houses,  they  advertise 
extensively  and  have  a  well  organized  corps  of  sales- 
men and  their  assistants  who  draw,  as  it  were,  a  fine- 
toothed  comb  through  the  investment  market.  A 
few  have  a  network  of  branch  offices  favorably  located 
throughout  the  country  and  others  their  out-of-town 
correspondents.  At  the  office  are  most  thorough 
systems  of  carding,  indexing,  filing,  compiling,  follow- 
ing up,  etc.  There  is  a  very  finely  classified  list  of 
investors,  institutional  and  individual,  to  whom  are" 
sent  circulars  describing  different  issues,  and  other 
information.  Statistics  are  kept  of  sales,  prices, 
fluctuations,  etc.,  of  all  securities  for  different  periods. 
Some  have  financial  libraries  containing  prospectuses, 


56  Investment  Bonds 

annual  reports,  mortgages,  reorganization  agreements, 
and  every  type  of  published  financial  information, 
which  facilities  are  usually  offered  to  investors.  Every 
phase  of  the  business  has  its  assigned  department  and 
systematization  is  the  watchword. 

Selling  of  bonds  is  becoming  more  and  more  a  field 
of  operation  for  national  banks  and  trust  companies, 
whose  methods  are  similar  to  those  of  the  large  bank- 
ing houses  though  their  equipment  is  not  so  complete. 
Activities  along  these  lines  are  practically  confined 
within  the  organization,  the  only  outside  agency  as- 
sisting being  possibly  a  branch  office  in  the  same  city. 
Their  profit  from  sales  of  bonds  is  a  minor  considera- 
tion, the  aim  being,  as  with  their  foreign  exchange 
business,  to  draw  a  clientele  that  may  be  useful  in 
other  ways. 

The  host  of  brokers  in  Wall  Street  handle  immense 
amounts  of  bonds.  Furthermore  there  are  small 
dealers  almost  without  number  who  derive  a  com- 
fortable income  from  fractional  profits  on  their 
transactions  and  still  another  class,  though  small, 
who  handle  only  this  kind  of  security  are  those 
who  might  be  called  bond  arbitrageurs.  They  go 
about  the  offices  of  larger  dealers,  ascertaining 
and  filling  their  needs,  acting  essentially  as  brokers, 
and  all  without  ever  purchasing  a  bond  on  their 
own  account. 

Thus  it  is  that  numerous  channels  lead  from  the 
issuing  company  to  the  investor.  A  bond  may  pass 
through  the  hands  of  half  a  dozen  dealers  before  it 
reaches  him. 

Unlike  stocks,  the  bulk  of  bonds  do  not  pass  through 
the  Exchange.  The  bond  business  is  largely  disas- 
sociated from  this  institution.  Consequently  the 


Processes  of  Issue  and  Negotiation        57 

amount  of  trading  in  these  securities  which  is  recorded 
on  the  "Board"  each  day  represents  only  a  small 
fraction  of  the  total  purchases  and  sales  that  take 
place  in  the  financial  district.  Government  bonds, 
for  instance,  are  quoted  and  dealt  in  to  some  extent, 
but  probably  nine  tenths  of  the  transactions  in r  this 
class  of  securities  take  place  in  the  banks  and  in  the 
offices  of  dealers  in  bonds,  a  process  of  selling  over 
the  counter  and  a  simple  operation.  The  course  of  a 
bond  from  investor  to  investor  through  selling  and  buy- 
ing broker  on  the  Exchange  is  more  complex.  Assume 
that  the  investor  has  bought  a  bond  from  a  banker. 
If  it  be  such  as  must  or  may  be  registered  the  work 
may  be  attended  to  by  either  the  purchaser  or  seller. 
The  owner's  name,  with  other  facts,  is  recorded  at 
the  registrar's  office.  Banking  houses  and  trust 
companies  quite  generally  act  as  registrars  and  also  as 
transfer  agents.  Desiring  to  sell  the  bond,  the  owner 
places  his  signature  of  endorsement  on  the  back.  If 
it  be  a  full  registered  form,  or  if  of  registered  coupon 
form,  he  signs  a  transfer  slip  which  constitutes  an 
assignment.  His  broker,  on  the  floor,  asks  a  price 
(usually  somewhat  above  what  he  expects  to  get) 
and  another  may  make  a  bid  (usually  lower  than 
he  expects  to  pay).  The  difference,  however,  is  not 
great.  A  disposition  to  trade  generally  brings  them 
to  a  common  ground  and  the  transaction  is  completed 
by  mutual  concessions. 

Their  trade  may  be  for  either  cash  or  regular  de- 
livery.  For  cash,  would  require  the  delivery  of  the 
bond  and  payment  therefor  the  same  day  that  the  pur- 
chase is  consummated.  All  sales,  unless  specified 
differently,  are  made  regular,  that  is,  deliverable  on 
the  following  day  except  in  cases  of  sales  or  purchases 


58  Investment  Bonds 

made  on  Friday  or  Saturday,  which  are  deliverable 
Monday.  From  considerations  of  safety,  the  Stock 
Exchange  rules  permit  only  unregistered  coupon  bonds 
to  be  a  good  delivery,  that  is,  pass  just  as  ordinary 
negotiable  paper  or  without  special  arrangements. 
Bonds  of  higher  denomination  than  $10,000  or  lower 
than  $500  and  bonds  in  names  of  executors,  guardians, 
trustees,  etc.,  are  not  good  delivery  except  by  special 
agreement. 

Careful  records  and  comparisons  are  made  of  every 
transaction,  very  much  as  with  stocks,  but  because 
of  the  relatively  small  aggregate  the  clearing  process 
is  unnecessary. 

Borrowing  bonds  on  sales  made  is  a  practice  little 
'in  vogue.  Large  amounts  of  stocks  are  borrowed  in 
order  to  fill  engagements,  but  the  expedient  of  what  is 
known  as  "seller  ten, "  "  fifteen, "  or  "twenty"  obviates 
the  necessity  of  borrowing  bonds  in  a  similar  way. 
These  "seller"  contracts  allow  the  broker  the  spec- 
ified number  of  days  in  which  to  obtain  the  necessary 
securities  and  make  delivery.  Should  a  broker  wish  to 
avail  himself  of  an  exceptionally  favorable  market, 
while  say  the  bonds  to  be  sold  were  in  transit  from 
another  country,  he  might  borrow  for  regular  delivery, 
but  generally,  if  the  bonds  are  not  at  hand,  a  "seller" 
contract  is  made.  This  style  of  transaction  resembles 
"short"  selling;  the  essential  difference  is  that  the 
broker  has  the  bonds  somewhere. 

Stock  Exchange  commissions  on  sales  of  bonds  are 
the  same  as  on  stocks,  namely,  one  eighth  of  one  per 
cent,  of  par  value. 

Record  of  transactions  in  bonds  on  the  Exchange 
is  furnished  to  the  public  through  several  mediums. 
Earliest  is  that  on  the  tape.  Immediately  after  a 


Processes  of  Issue  and  Negotiation        59 

trade,  the  number  of  bonds  involved  and  the  price 
of  sale  appears  there.  Only  bonds  in  the  Listed  de- 
partment, however,  are  reported  in  this  way.  Twice 
a  day,  at  one  o'clock  and  the  close  of  business,  the 
Exchange  issues  a  quotation  sheet  giving  the  bid  and 
asked  prices  and  all  transactions.  Supplementing 
these,  the  newspapers  contain  practically  the  same 
information.  These  Stock  Exchange  quotations  are 
only  approximate;  they  do  not  represent  the  actual 
market  at  all.  A  quotation  may  be  established  by  a 
bid  or  offer  of  bonds,  which  though  good  for  the  moment 
would  not  hold  should  an  outsider  desire  to  dispose 
of  a  considerable  quantity  of  bonds.  Particularly  is 
this  the  case  with  Government  bonds  where  the  quo- 
tations are  made  by  one  or  two  large  dealers  to  give 
the  impression  that  the  bonds  are  worth  the  price 
bid.  As  a  rule,  the  actual  market  is  somewhere  be- 
tween the  quotations  given  on  the  Exchange. 

Two  methods  of  quotation  are  used  in  Wall  Street. 
On  the  Exchange,  flat  prices  are  made;  private  bond 
dealers  generally  quote  "and  interest."  The  former 
means  the  sum  of  a  certain  price  and  the  accumulated 
interest  from  the  last  interest  period;  the  latter  def- 
initely states  the  price,  the  accumulated  interest  to 
be  figured  at  the  time  of  sale.  In  a  final  analysis 
they  are  but  different  expressions  of  one  thing. 

New  York  is  the  great  and  central  market  for  bonds 
and  most  of  the  large  and  active  issues  are  put  upon  its 
Exchange.  The  process  is  similar  to  that  employed 
with  stock,  and,  as  in  the  stock  branch,  there  are  two 
departments,  Listed  and  Unlisted.  Those  in  the 
Listed  department,  where  the  majority  of  railroad 
bonds  are,  do  not  fluctuate  widely,  and  take  the  form 
of  solid  investments  rather  than  speculative  issues. 


60  Investment  Bonds 

Government,  certain  State,  railroad,  and  many  cor- 
poration bonds  are  listed,  while  in  the  Unlisted 
department  are  to  be  found  many  industrial  secur- 
ities. Some  corporation,  all  municipal,  and  most  State 
bonds  are  neither  quoted  nor  dealt  in  on  the  Exchanges. 
Especially  large  railroad  issues  are  occasionally  listed 
abroad. 

That  the  quotation  for  bonds  of  an  issue  should 
be  made  before  they  are  placed  on  the  market  seems 
odd.  Yet  on  the  "Curb"  market  trades  are  made  on 
the  bare  suspicion  of  such  action  and  speculation  is 
often  brisk  in  these  hypothetical  securities  that  may 
or  may  not  be  issued.  The  method  is  to  qualify  the 
contract  by  the  phrase  "when,  as  and  if  issued." 
Sometimes  large  transactions  take  place.  It  is  usually 
/  the  experience  that  these  quotations  are  somewhat 
above  the  subscription  price. 


CHAPTER  V. 

LIMITATIONS. 

AROUND  the  process  of  issue  of  investment  bonds 
are  thrown  certain  restrictions,  at  once  wise  and 
necessary.  They  are  rigid  or  lax,  few  or  many,  much 
according  to  the  class  of  corporation  affected.  Oppor- 
tunities for  fraud  are  not  yet  absent;  indiscretion  is 
quite  within  the  range  of  possibility;  error  is  not  yet 
eliminated  from  corporate  action.  These  restrictions 
may  be  self-imposed  or  the  weight  of  authority;  they 
may  be  external,  the  mandate  of  law;  or  internal, 
organic  regulations. 

Least  affected  is  the  Government.  Constitutional 
limitations  as  to  debt  or  details  of  issue  are  absent 
and  the  Secretary  of  the  Treasury  is  little  circum- 
scribed by  rules  or  regulations  of  Congress  in  the 
conduct  of  bond  issues.  To  be  sure,  the  authorizing 
acts  are  specific  in  their  terms,  but  also  simple  and 
free  from  minor  restrictions.  While  not  customary, 
the  restriction  that  par  is  the  lowest  price  acceptable 
is  occasionally  incorporated  in  a  measure  as  it  passes 
Congress.  The  recent  $30,000,000  Panama  Canal 
issue  was  one  such. 

Some  of  the  State  constitutions  prohibit  the  creation 
of  any  debt  except  in  an  emergency,  as  in  the  case  of 
invasion  or  rebellion;  others  contain  provisions  limit- 

61 


62  Investment  Bonds 

ing  the  amount  of  debt  that  can  be  contracted  by 
the  State  authorities  up  to  a  certain  percentage  of  the 
assessed  valuation  of  real  estate,  still  others  restrict 
their  respective  states  to  an  outstanding  issue  not  to 
exceed  a  fixed  amount,  and  a  few  seem  to  have  no 
provisions  limiting  the  power  of  the  legislature  to 
create  State  debt.  Constitutional  limitations  do  not 
affect  details  of  issues;  the  legislative  act  authorizing 
an  issue  usually  embodies  these.  Such  as  exist  pertain 
to  par  value,  conditions  of  sale,  etc. 

Municipalities,  however,  are  hedged  about  by  many 
restrictions,  constitutional  and  statutory,  as  to  con- 
traction of  debt  and  particulars  of  bond  issue.  In 
many  states  they  are  only  indirectly  constitutional 
inasmuch  as  power  is  delegated  to  the  legislative  body 
to  prescribe  for  such  matters  by  statutes  special  and 
general.  Again  in  others  the  constitution  puts  a 
general  and  uniform  limit  to  power  of  all  counties  and 
cities  to  contract  and  put  out  their  obligations,  leaving 
the  legislature  to  fix  the  debt-making  power  of  villages 
and  towns. 

v  Based  on  assessed  valuation,  percentages  vary  in 
different  states.  They  are  uniform  or  graduated  to 
the  size  of  the  municipality  and  run  from  two  to  ten 
per  cent,  of  the  taxable  property  contained  therein. 
New  York  permits  its  cities  and  counties  to  become 
indebted  to  the  extent  of  ten  per  cent.  In  some  cases 
the  assessment  on  which  percentages  are  based  is 
taken  periodically  — in  others  it  is  the  last  one. 

In  a  few  instances  the  borrowing  capacity  of  a  city 
has  no  limit  but  for  each  loan  the  legislature  must  pass 
an  enabling  act;  the  council  must  pass  an  ordinance 
and  the  proposed  loan  must  be  approved  by  the  people. 
Baltimore  is  a  case  in  point. 


or  THE 
UNIVERSITY 

Limitations  63 

Laws  in  regard  to  limitation  of  indebtedness  are 
ineffective  in  some  cases.  The  fact  that  a  municipality 
may  have  frequent  recourse  to  the  legislature  to  exceed 
its  debt  limit  (and  generally  have  its  request  granted) 
vitiates  them  to  a  considerable  extent.  For  instance, 
a  certain  city  of  New  England  has  a  net  debt  of  twice 
the  amount  permitted  by  law,  but  as  often  as  the  city 
council  asks  it  is  permitted  to  issue  more  bonds. 

So  far  as  laws  or  ordinances  affect  the  bond  issues 
specifically,  a  few  facts  should  be  noted.  Some  states 
particularly  designate  the  par  value  of  municipal 
bonds.  Injunctions  of  this  character  may  be  well 
adapted  in  cases  but  generally  there  is  no  prohibition 
of  various  denominations.  Restrictions  that  all  bonds 
must  be  sold  at  par  or  higher  are  almost  universal  with  ' 
municipalities;  what  few  exceptions  exist  are  cities 
of  fewer  than  a  prescribed  number  of  inhabitants  which 
are  permitted  to  dispose  of  their  obligations  at  a 
slightly  lower  figure. 

Maximum  and  minimum  maturity  are  often  speci-  V 
fically  stated;  different  states  compel  different  matur- 
ities. Municipalities  quite  generally,  especially  cities, 
are  forbidden  to  pay  an  interest  rate  above  a  certain 
per  centum  per  annum;  different  states,  however, 
permit  different  rates  of  interest  in  different  sized 
municipalities. 

Then  there  are  statutory  provisions  as  to  the  form  of 
bond  a  municipal  corporation  may  issue  and  again 
limitations  as  to  the  purpose  involved. 

As  to  limitations  affecting  bond  issues  of  corpora- 
tions other  than  public,  few  are  statutory.  About  the 
only  corporations  under  law  in  this  respect  are  those 
operating  by  virtue  of  municipal  franchises,  and  they 
not  generally.  A  few  states  limit  the  application  of 


64  Investment  Bonds 

proceeds  of  bond  issues  to  certain  purposes,  and  here 
and  there  interest  is  limited  to  the  legal  rate  or  some 
specified  amount  as,  for  instance,  in  the  case  of  street 
railways  in  Ohio  where  it  cannot  exceed  seven  per 
cent.  To  a  somewhat  greater  extent,  states  limit  the 
period  of  life  for  bonds  of  corporations  acting  under 
such  franchises. 

In  England  the  issue  of  railway  securities  was  regu- 
lated forty  years  ago.  In  the  United  States,  however, 
there  is  still  no  general  legislation  limiting  the  power  of 
corporations  to  issue  stocks  and  bonds,  nor  has  Con- 
gress ever  issued  a  law  restraining  managers  so  that  a 
fraudulent  issue  would  be  impossible. 

Notwithstanding  these  facts,  evolution  in  finance 
has  wrought  out  practices  and  principles  that  have 
become  well-nigh  classic,  and  which,  in  themselves, 
are  a  most  efficient  check  to  corporate  misdoing  and 
error.  Especially  is  this  true  of  railroad  finance  where 
bond  issues  are  frequent  and  great. 

Most  of  such  issues  are  secured  by  a  mortgage  and 
this  document  held  by  a  trustee.  Under  the  process 
of  certification,  already  described,  and  such  trustee- 
ship, there  is  an  effectual  check,  and  fraud  or  bad  faith 
are  difficult  of  accomplishment. 

But  primarily  there  are  various  restrictions  to  the 
issuance  of  the  definitive  securities  of  many  railroads. 
A  mortgage  may  expressly  provide  that  bonds  in  excess 
of  a  certain  amount  shall  not  be  certified  by  the  trustee 
except  upon  the  written  request  of  stockholders  owning 
at  least  fifty-one  per  cent,  of  the  capital  stock  of  the 
company,  specifying  the  amount  of  bonds  so  to  be 
issued;  or,  again,  it  may  provide  that  only  so  many 
bonds  of  the  total  authorized  issue  may  be  issued  each 
year,  also  stipulating  that  this  amount  is  to  be  used 


Limitations  65 

only  for  specific  purposes,  perhaps  betterments  and 
improvements.  The  latter  expedient  was  quite  gen- 
erally used  in  the  railroad  reorganizations  of  recent 
years.  Large  bond  reserves  issuable  over  a  series  of 
years  have  been  provided  for  lest  the  stockholders 
refuse  to  authorize  a  necessary  issue  if  left  to  their 
discretion. 

Very  frequently  a  portion  of  an  issue  is  held  in  escrow 
and  may  only  be  issued  under  certain  conditions,  or 
is  held  for  the  retirement  of  prior  lien  bonds.  In  the 
construction  of  new  work,  the  trustee  of  the  bonds  is 
generally  permitted  to  issue  them  only  in  amounts  to 
correspond  with  certified  statements  from  the  engineers 
in  charge  which  cover  the  actual  cost  of  construction 
as  the  work  progresses. 

Perhaps  the  most  effective  safeguard  against  ex- 
travagance in  the  issue  of  railroad  bonds,  where  new 
construction  is  involved,  is  the  per  mile  basis.  Here 
the  approximate  cost  of  the  new  work  per  mile  is  care- 
fully calculated  and  the  bonds  issued  accordingly. 
The  amounts  vary  greatly;  under  descending  mort- 
gages they  become  proportionately  less  per  mile.  A 
great  many  conditions  enter  to  fix  the  amounts.  Aside 
from  whether  it  is  double  or  single  track,  main  or 
branch  line,  side  or  main  track,  many  engineering 
and  economic  conditions  must  be  considered.  While 
amounts  vary,  the  average  bonded  debt  per  mile  in 
the  United  States  is  about  $35,000. 


CHAPTER  VI. 

LEGALITY. 

CONSIDERATION  of  this  question  is  almost  wholly 
with  reference  to  municipal  bonds.  It  has  no  place 
in  a  study  of  Government  obligations  and  is  a  matter 
of  little  concern  in  State  issues,  save  in  the  measure 
that  constitutional  restrictions  or  regulations  are 
involved.  Like  those  of  the  Government,  bonds  of 
all  other  than  public  corporations  are  unaffected  by 
this  question;  conditions  governing  their  issue  and 
affecting  their  life  are  distinctive  and  in  most  cases 
the  investor  is  protected  by  security  in  tangible  form. 
Questions  of  law  affecting  such  bonds  go  back  to 
legality  of  the  mortgage  under  which  issued.  Counsel, 
therefore,  of  the  corporation  issuing  the  mortgage 
certifies  to  its  propriety  and  lawfulness  and  drafts 
of  the  mortgage  and  bond  are  usually  submitted  to 
the  trustee  (generally  a  trust  company)  for  the 
examination  and  approval  of  their  counsel.  This 
proceeding  accomplishes,  in  effect,  what  a  certifi- 
cation of  legality  does  for  municipal  bonds.  With 
thousands  of  municipalities  throughout  the  land 
issuing  hundreds  of  millions  of  dollars  of  bonds,  for 
innumerable  purposes,  with  officers  of  varying  degrees 
of  efficiency,  integrity,  and  ability  to  interpret  the 
law  correctly,  the  question  of  legality  is  of  much 
consequence. 

66 


Legality  67 

Its  importance  arises  from  a  threefold  considera- 
tion ;  safety  of  the  investor ;  reputation  and  standing 
of  the  corporation;  and  interests  of  the  taxpayers. 
Personal  knowledge  of  the  laws  governing  these  mat- 
ters is,  of  course,  impracticable,  for  the  majority  of 
investors,  hence  others  must  vouch  for  the  safety  and 
integrity  of  the  obligation.  Should  this  precaution  be 
neglected,  the  investor  faces  the  possibility  of  loss, 
partial  if  not  absolute,  according  to  the  existing  cir- 
cumstances. 

Notwithstanding  the  fact  that  validity  of  municipal 
bonds  is  rarely  questioned  once  in  the  hands  of  inves- 
tors, buyers  should  be  ever  mindful  that  an  issue  is 
void,  even  in  possession  of  innocent  and  bona-fide 
holders  if  emanating  illegally,  without  the  authority 
of  law. 

What  is  the  fate  of  the  investor  in  possibly  illegal 
bonds?  The  municipality  is  enjoined  from  interest  or 
principal  payments  and  an  interminable  quarrel  is 
provoked.  Suit  is  instituted,  beginning  litigation  that 
may  hold  the  bonds  for  years  and  years.  Meanwhile, 
and  until  the  question  is  determined,  the  investors* 
money  is  withheld  and  in  the  end  he  may  lose  all  on 
an  adverse  decision  of  the  courts. 

More  frequently,  suit  and  injunction  are  brought 
against  the  municipality  before  the  issue  is  sold.  Upon 
the  initial  step  or  as  soon  as  it  is  advertised,  proceedings 
are  begun  challenging  the  right  to  undertake  the  work 
for  which  the  bonds  are  contemplated. 

From  the  issuing  corporation's  viewpoint,  the 
wisdom  of  assured  legality  is  apparent.  Corporations 
may  have  no  soul,  so  often  asserted,  but  they  do  have 
reputations.  Let  a  municipality  put  out  one  or  two 
illegal  issues  and  sooner  or  later  it  becomes  a  party 


68  Investment  Bonds 

in  annoying  litigation.  Sufficient  is  this  evil  of  itself, 
but  its  effects  are  worse.  An  unsavory  reputation  is 
not  conducive  to  public  confidence.  Every  corpor- 
ation needs  additional  funds  from  time  to  time  and 
to  obtain  them  readily  must  court  public  favor.  A 
municipal  corporation  therefore,  must  needs  be  cautious 
lest  it  find  its  credit  waning  and  its  debt  limit  not 
the  prescribed  percentage  of  its  assessed  valuation 
but  its  inability  to  borrow  needed  funds ;  or,  the  equiv- 
alent, bids  for  its  obligations  at  discount. 

An  occasional  illegal  issue  may  find  its  way  into 
the  market  but  fraudulent  bonds  are  seldom  heard 
of  nowadays,  at  least  from  a  corporation  standpoint. 
Several  extensive  forgeries  of  municipal  bonds  by 
outside  individuals  have  been  unearthed  within  the 
past  few  years  but  any  but  genuine  from  the  corpo- 
ration are  practically  unknown. 

If  the  question  of  legality  is  of  such  moment  to 
investor  and  corporation,  the  interests  of  the  taxpayer 
must  not  be  overlooked.  Inasmuch  as  retirement  of 
bonds  and  payment  of  interest  charges  are  generally 
the  result  of  taxation,  the  purpose  of  their  issue  and 
the  whole  process  must  be  legal  to  make  the  tax  for 
their  payment  legal.  Self  protection  is  a  fundamental 
principle  with  those  on  whom  the  burden  falls,  so  that 
almost  always  institution  of  legal  proceedings  is  the 
act  of  one  or  several  taxpayers. 

Absolute  validity  is  a  matter  that  has  received  much 
'  consideration  by  some  states.  Texas  has  made  it  the 
duty  of  the  Attorney  General  to  examine  all  proceedings 
connected  with  the  issue  of  bonds  by  cities,  towns,  and 
counties,  and  before  any  bonds  are  sold  he  must  fur- 
nish a  certificate  that  they  are  lawful  obligations.  In 
the  State  of  Georgia,  where  no  bonds  can  be  issued 


Legality  69 

without  the  consent  of  the  electors,  by  vote,  the  law 
provides  for  having  the  Superior  Court  determine 
the  validity  of  proposed  bond  issues  and  judgment 
in  the  affirmative  having  been  given,  they  can  never 
be  called  in  question.  In  Colorado  the  various  munici- 
pal issues  must  be  registered  on  the  books  of  the 
County  Auditor  and  the  tax  levy  for  the  payment  of 
the  principal  and  interest  certified  annually  by  him. 
Provisions  such  as  these  might  well  be  considered  by 
legislatures  of  other  states  and  would  save  in  interest 
many  thousands  of  dollars  to  the  taxpayers. 

Many  points  are  involved  in  the  authority  of  mu- 
nicipal corporations  to  issue  bonds.  Laws  vary  greatly, 
being  different  in  almost  every  State.  Almost  the 
first  question  to  be  asked  is  whether  they  are  issued 
in  strict  accordance  with  law;  whether  the  officials 
in  charge  have  complied  with  every  one  of  its  provis- 
ions. Complete  enumeration  of  all  such  points  to  be 
considered  is  impracticable,  but  their  general  char- 
acter may  be  understood  by  mention  of  a  few. 
V  First,  and  perhaps  most  important,  is  the  matter 
of  debt  limit;  so  vital  is  this,  that  much  time  is  spent 
and  scrutiny  exercised  on  it.  The  borrowing  margin 
between  the  total  outstanding  debt  and  the  legal 
limit  is  often  a  matter  of  doubt  and  discussion,  espec- 
ially in  large  cities,  owing  to  the  differences  of  opinion 
in  the  classification  of  the  debt.  It  is  therefore  es- 
sential that  this  point  be  settled  with  considerable 
defmiteness  and  to  know  that  the  added  debt  does 
not,  perchance,  violate  this  provision  of  the  law. 

Often  a  popular  vote  is  necessary  to  authorize  an 
issue  of  bonds ;  when  so,  the  legality  of  the  proceedings 
and  all  attendant  formalities  must  be  carefully  ex- 
amined. The  required  advertisement  may  have  been 


70  Investment  Bonds 

inadvertently  overlooked,  which  might  prove  serious 
should  it  come  before  a  court. 

Were  the  proceeds  properly  applied,  and  is  the  object 
of  their  application  legal,  are  among  the  important 
questions  to  be  asked  and  answered.  Frequently  the 
courts  have  declared  an  issue  illegal  and  void  because 
issued  in  assistance  of  an  enterprise  not  distinctly 
public  in  its  nature  and  benefits. 

Generally  speaking,  such  matters  as  assessed  valu- 
ation and  amount  of  indebtedness  may  be  easily 
learned  from  official  statistics,  but  full  legality  is  a 
matter  which  requires  considerable  investigation  and 
knowledge  of  law  and  the  general  conditions  affecting, 
and  is,  therefore,  not  generally  known  to  the  investor. 

Obviously,  then,  some  authoritative  assurance  of 
safety  from  the  legal  point  of  view,  is  necessary.  Mu- 
nicipalities do  not  generally  undertake  to  have  issues 
certified  as  to  their  legality.  That  falls  to  the  first 
purchaser.  As  the  majority  of  such  issues  are  taken 
entirely  by  bankers,  they  naturally  attend  to  this 
detail.  Attorneys,  generally  of  their  own  selection, 
carefully  investigate,  and  as  a  result  prepare  an  opinion 
embodying  their  conclusions  which  is  filed  at  some 
accessible  place,  often  with  a  trust  company. 

On  the  bond  itself  is  engraved  what  is  consid- 
ered the  certification  and  is  in  general  form  about  as 
follows : 

The  original  opinion  of  (Attorney)  relative  to  the 
validity  of  this  issue  and  all  legal  papers  are  filed  for  in- 
spection of  the  holder  hereof,  with  the  United  States 
Mortgage  and  Trust  Company. 

Half  a  dozen  law  firms  in  New  York  City  enjoy 
the  greater  part  of  this  business.  The  financial  position 


Legality  71 

of  the  city  makes  it  the  focus  of  the  bond  market  and 
naturally  certification  by  some  of  its  well-known 
firms  carries  much  weight;  in  fact,  several  make  this 
work  a  specialty. 

Many  people  are  prone  to  confuse  this  certification 
with  that  which  is  usually  done  by  trust  companies, 
who  certify  to  genuineness  but  do  not  vouch  for  its 
validity.  The  distinction  should  be  clearly  noted; 
one  involves  right  to  issue;  the  other  accuracy  and 
integrity  of  execution  of  the  process,  or,  in  other 
words,  exercise  of  the  right. 

A  municipal  issue  may  be  invalid  from  either  the 
absence  of  right  to  issue  or  through  unsystematic 
methods  of  preparation  and  execution.  In  fact,  the 
most  fraud,  duplication,  and  errors  have  occurred  for 
this  latter  reason. 

No  written  laws  require  certification  of  municipal 
bonds,  but  when  municipalities  sell  directly  to  inves- 
tors, they  generally  follow  the  bankers'  custom  in  this 
respect  and  in  their  newspaper  advertisements  the 
fact  is  mentioned. 

So  universal  and  essential  is  the  practice  that  on  it 
largely  hinges  the  worth  of  most  municipal  issues  as 
investments.  Some  investors  would  not  consider  such 
a  bond  without  this  certification  and  then,  too,  except 
by  certain  law  firms.  In  a  word,  its  net  effect  is  to 
enhance  the  obligation  in  the  market,  contributing  in 
assuring  its  distribution  and  toward  stability  and  price. 


CHAPTER  VII. 

MARKET. 

DISCUSSION  of  the  bond  market  may  proceed  entirely 
from  either  of  two  viewpoints.  Transactions  of  a 
single  week  may  serve  as  a  text  in  the  discussion  of  one 
of  these  aspects.  Take  reports  of  bond  sales  for  any 
week,  and,  aside  from  total  amount,  little  is  to  be 
learned  except  prices  at  which  they  changed  hands. 
The  average  newspaper  and  financial  reports  and 
financial  columns  are  written  almost  wholly  from  this 
viewpoint  so  that  the  conception  of  market  as  drawn 
from  such  reading  is  prices.  Not  only  the  printed  page, 
but  the  spoken  word,  too,  conveys  nothing  other  than 
the  idea  of  quotation.  Such  usage  of  the  term  market 
is  fundamentally  correct  and  generally  conveys  suffi- 
cient information  for  the  purposes  and  operations  of 
business,  though  incomplete  in  the  sense  that  it  fails  to 
imply  many  interesting  facts  of  distribution. 
/  To  be  sure,  the  banker's  chief  concern  is  with  the 
\  price  at  which  he  is  able  to  dispose  of  his  securities,  yet 
he  must  have  a  comprehensive  knowledge  of  their 
distribution.  He  knows  what  is  almost  axiomatic, 
that  the  broader  the  distribution  the  higher  the  quota- 
V  tion ;  that  a  widening  market  immediately  affects  their 
price;  that  broad  distribution  and  a  high  price  mean 
comparatively  narrow  fluctuations  in  that  price. 

73 


Market  73 

Full  treatment  of  the  subject,  therefore,  must  pro- 
ceed from  the  basis  of  its  division  into  two  parts, 
namely,  price  and  distribution,  separate  and  distinct 
from  each  other  but  with  relations  so  close  as  to  make 
them  complementary  and  the  consideration  of  either 
a  corollary  to  the  other.  The  complexity  of  these  re- 
lations almost  defies  analysis;  they  shade  into  each 
other  with  imperceptible  gradations;  are  interwoven 
as  the  warp  and  woof  of  a  fabric;  are  mutually 
dependent. 

In  its  simplest  expression,  the  market  for  this  class 
of  investment  instrument  is  the  demand.  But  demand 
is  the  product  of  conditions  and  circumstances  which 
vary  in  intensity  and  with  time;  their  play  causes  its 
rise  and  fall  and  their  effect  is  good  or  evil,  local  or  uni- 
versal, much  according  to  their  nature.  It  is  the  pur- 
pose here  to  note  specifically  the  most  important  of 
these  conditions,  inquiring  into  their  relations  with 
each  other  and  with  the  market  in  general  in  its  two- 
fold aspect. 

Rather  strict  construction  may  be  put  upon  the 
term  demand  by  interpreting  it  more  in  the  light  of 
pure  investment  than  otherwise.  Any  purchase  of 
bonds,  is,  of  course,  demand,  whether  for  specula- 
tion or  permanent  investment,  as  these  terms  are 
understood;  whether  held  for  several  weeks  or  a  num- 
ber of  years  and  the  lines  of  distinction  cannot  be 
finely  drawn,  but,  in  its  truest  sense,  it  is  the  call  for 
investment. 

In  the  bond  market  (speaking  especially  of  Stock 
Exchange  operations),  appearances  are  sometimes 
deceptive;  what  appears  to  be  a  demand  is,  in  lesser 
degree  but  nevertheless  as  genuinely  as  in  the  stock 
market,  manipulation  of  prices.  In  the  parlance  of 


74  Investment  Bonds 

bond  and  stock  market  there  is  a  "made"  market 
which  generally  implies  that  by  manipulation  and 
fictitious  sales  a  quotation  has  been  established,  at 
least  for  the  time  being.  Thus  the  quotation  is 
"fixed"  and  the  tape  put  up  to  give  the  impression 
the  bonds  are  worth  the  prices  bid.  Investors  are 
deluded  into  buying  and  in  a  few  days  find  prices 
recede  perhaps  a  point  or  two.  Syndicates  that 
are  unsuccessful  in  marketing  their  bonds  as  read- 
ily as  anticipated,  sometimes  resort  to  this  means 
of  creating  higher  quotations.  The  fictitiousness  of 
such  a  market  and  its  worthlessness  as  a  criterion  of 
value  are  apparent. 

A  fictitious  market  generally  means  forced  and 
unnatural  prices,  which  should  not  be  confused  with 
an  artificial  market  that  may  be  absolutely  genuine. 
In  the  United  States  is  an  unparalleled  example  of  the 
latter  where  the  basis  is  accidentals  rather  than  essen- 
tials, and  the  consequent  artificiality  is  seen  in  both 
price  and  distribution.  It  is  the  product  of  the  banking 
system  of  this  country  which  requires  the  use  of  Govern- 
ment bonds  for  various  purposes;  a  system  expressly 
designed  to  make  a  market  for  these  obligations  during 
the  stress  of  Civil  War  times.  This  necessity  has  now 
passed  yet  the  banking  system  remains  practically 
unchanged  and  continues  to  perform  this  function  per- 
fectly. For  this  reason  the  expressed  intent  of  the  law 
miscarries  with  Government  bonds;  though  supposed 
to  be  popular  and  widely  distributed,  they  find  lodg- 
ment to  the  extent  of  fully  seventy-five  per  cent,  in  the 
national  banks  of  the  country. 

Merely  as  bonds  they  stand  in  unfair  comparison 
with  others  quite  as  good;  their  price  is  entirely 
artificial  and  is  sustained  by  the  demand  for  them 


Market  75 

for  the  various  purposes  other  than  pure  investment. 
Remove  these  conditions  and  it  is  not  unlikely  they 
would  decline  considerably,  especially  in  view  of  the 
growing  credit  of  many  industrial,  railroad,  and  other 
corporations. 

In  contrast  to  United  States  Government  bonds, 
for  instance,  are  British  Consols.  Lacking  a  corre- 
sponding stimulus,  these  famous  national  bonds  sell 
at  a  discount  of  from  ten  to  twelve  per  cent,  whereas 
not  one  issue  of  our  Government  is  quoted  to-day  at 
less  than  par. 

In  a  sense,  there  may  be  at  least  temporarily  an 
artificial  market  for  any  bonds.  Far  fetched  though 
this  may  be  it  is  consistent  with  our  premise  that  a 
true  market  is  a  legitimate  investment  demand. 
Blocks  of  bonds  bought  purely  on  speculation  with 
an  intention  of  selling  at  the  first  advance,  and  large 
issues  held  by  underwriting  syndicates,  are  really 
temporary  rather  than  permanent  investments  and 
hardly  serve  as  ground  for  conclusions. 

Fictitious  and  artificial  price  and  distribution, 
though  potent  realities  in  the  bond  business,  are 
anomalies. 

Laws  of  cause  and  effect  operate  in  the  bond  market 
with  absolute  precision;  effects  are  obvious — causes 
are  not  easily  discernible  except  by  the  expert.  A 
depression  in  price  for  an  issue  is  a  matter  of  recorded 
fact,  easily  and  quickly  apprehended;  conditions  of 
which  it  is  the  resultant,  are  often  obscure  and  col- 
lective. Distribution  of  the  great  mass  of  bonds  is 
a  comprehensive  study  and  the  causes  that  largely 
determine  it  are  many  and  varied. 

They  may  be  designated  as  special  and  general, 
or,  accidental  and  fundamental,  or,  temporary  and 


76  Investment  Bonds 

permanent;  all  of  which  at  best  are  but  arbitrary 
classifications.  Some  conditions  affect  both  price  and 
distribution;  some  affect  but  one  of  these.  The  in- 
fluence of  some  is  felt  at  certain  times  and  again  the 
influence  of  some  is  felt  always.  Special  conditions, 
as  a  rule,  affect  the  marketing  of  the  individual  issue; 
while  general  conditions  are  broad  in  scope  and  far- 
reaching  in  effect  and  may  be  felt  throughout. 

Market,  as  we  have  said,  is  the  demand.  To  realize 
a  good  price  and  secure  ready  distribution  there  must 
be  balance  of  supply  and  demand.  Corporations  of 
any  kind  must  regard  the  time  of  issue.  The  volume 
of  such  forms  of  credit  must  not  exceed  the  demand. 
The  ability  and  willingness  of  the  market  to  absorb 
must  be  considered.  If  time  of  issue  affects  the  mar- 
ket, the  converse  is  also  true.  Naturally,  corporation 
managers,  under  advice  from  their  bankers,  avoid 
flooding  the  market  at  an  inopportune  time.  But 
occasionally  necessity  demands  that  strictest  caution 
and  judgment  be  set  aside  in  some  measure  and  a 
corporation  is  compelled  to  put  out  a  bond  issue  to 
that  extent  regardless  of  this  fundamental  principle. 

The  depressed  condition  of  municipal  credit  in  New 
York  City  during  the  year  1907  was  attributed  largely 
to  this.  One  of  the  principal  causes,  it  is  held,  is  that 
large  issues  have  followed  each  other  in  such  rapid 
succession  as  to  reach  a  point  of  saturation.  The 
demand  which  absorbs  municipal  bonds  of  high  grade 
is  fairly  constant  and  largely  of  local  origin,  but  there 
is  such  a  thing  as  satiating  even  so  avid  appetite  as 
the  investing  public  sometimes  has. 

Simultaneous  issues  to  any  great  extent,  by  dif- 
ferent corporations,  is  also  to  be  averted.  Unless  the 
market  is  unusually  good,  some  of  the  issues  thrown 


Market  77 

at  once  into  it  are  bound  to  suffer  in  price  and  ab- 
sorption is  sure  to  be  retarded.  In  1906,  coincidental 
with  the  flotation  of  the  Government  Panama  loan, 
New  York  City  issued  $20,000,000  of  its  obligation. 
This  fact  was  made  to  account,  in  large  measure,  for 
the  low  average  price  received  and  the  paucity  of 
bids.  Thus  it  is  that  simultaneous  issues  and  those 
of  rapid  succession  militate  against  their  own  good. 
A  depression  in  their  price,  if  sufficiently  pronounced, 
is  likely  to  affect  the  entire  market. 

What  are  the  conditions  which  influence  investors 
in  their  judgment  as  to  the  value  of  bonds  and  their 
readiness  to  take  them?  Underlying  all  other  con- 
siderations is  that  of  confidence.  Public  distrust  of 
the  methods  of  high  finance;  pessimism  as  to  the 
business  outlook;  a  lack  of  faith  in  the  stability  of 
an  enterprise — all  these,  with  others,  have  their  reflex 
in  the  dulness  of  the  bond  market.  The  demand  for 
good  bonds  is  generally  a  barometer  of  the  public's 
disposition ;  this  was  never  more  manifest  than  during 
the  year  1903  when  through  the  wholesale  disturbance 
of  confidence  in  general,  the  shrinkage  in  prices  was 
most  pronounced.  In  further  demonstration  of  this, 
New  York  Stock  Exchange  figures  show  that  in  a 
certain  week,  shortly  after  the  Japanese  Government 
issues  were  put  into  the  market,  well-nigh  one  half 
of  the  bond  transactions  on  that  board  were  in  these 
bonds.  In  the  face  of  conditions  most  adverse,  this 
was  remarkable,  and  cannot  be  considered  as  due  to 
anything  more  particularly  than  to  the  confidence  of 
investors  in  these  particular  securities. 

Confidence  and  its  opposite  are  terms  representing 
states  of  feeling  widespread  and  infectious.  Akin 
to  these  but  rather  local  in  its  operation  is  sentiment. 


78  Investment  Bonds 

It  may  affect  an  individual  issue,  a  particular  type 
of  bond,  or,  in  fact,  a  whole  class  of  bonds.  Sentiment 
plays  quite  a  part  in  the  purchase  of  bonds,  as  truly 
as  in  stock-buying.  Much  attention  is  paid  to  the 
sentiment  of  Wall  Street  in  regard  to  bonds.  Should 
a  dealer  be  prejudiced  against  a  security,  he  hesitates 
to  recommend  its  purchase.  Something  of  this  spirit 
in  investors  foretells  a  low  price  and  narrow  market. 
So  far  as  apparent  on  the  surface,  the  bond  may  be 
excellent,  but  such  an  attitude  is  generally  not  without 
its  foundation. 

Prejudice  against  a  certain  class  of  securities  may 
pervade  an  entire  community.  In  some  of  the  Western 
States,  especially  in  farming  sections,  for  instance,  a 
pronounced  antipathy  exists  against  municipal  bonds. 
Sad  and  wise  as  the  result  of  past  experience  with 
wholesale  repudiation,  they  will  have  few  of  them. 

Consistent  with  this  attitude  they  issue  few  such 
obligations,  holding  to  the  theory  that  bonds  are  detri- 
mental to  a  community.  So  rooted  in  this  are  they 
that  some  sections  mutually  agree  to  stand  a  five-  or 
seven-year  extra  levy  of  taxes  in  order  to  build  a  new 
court-house  or  a  bridge  rather  than  have  a  bond  issue. 

On  the  other  hand,  sentiment  in  its  favorable  ex- 
pression often  makes  a  market.  The  spirit  of  neigh- 
borliness  and  pride  so  pervades  some  sections  that 
local  issues  will  always  have  preference.  Patriotism 
and  business  are  indeed  sometimes  mingled  in  this  way. 

Western  sentiment  against  municipal  issues  shows 
in  a  measure  that  the  class  of  a  corporation  influences 
the  market  for  its  bonds.  The  time  is  now  when  the 
investing  public  is  discriminating  and  bonds  of  some 
corporations  are  slow  of  sale  and  low  in  quotation. 
In  proof  of  this  is  what  every  observer  of  the  market 


Market  79 

knows — that  the  general  favor  in  which  railroad  bonds 
are  held  makes  some  of  the  lower-class  issues  bring 
higher  prices  than  mortgage  bonds  of  industrial  com- 
panies. Again,  municipal  bonds,  generally  very  good 
securities,  are  not  as  marketable  as  most  railroad 
bonds. 

Corporate  conditions  are  largely  responsible  for 
this  state  of  affairs.  That  bonds  of  older  and  larger 
railroads  should  be  universally  considered  as  a  high- 
class  investment  is  due  to  the  fact  that  they  have 
established  a  position  which  gives  them  a  standing 
in  the  world  of  credit.  Of  late  years  earnings  have 
been  put  into  the  properties  and  greater  operating 
efficiency  and  earning  powder  have  been  the  order  of 
the  day,  so  that  investors  are  coming  to  regard  them 
with  increasing  favor. 

Industrial  issues  suffer  correspondingly  for  a  number 
of  reasons.  Some  of  these  corporations  are  top-heavy 
with  capitalization.  Often  too  much  of  this  is  bonded 
debt.  Their  operations  are  veiled  in  secrecy  and 
their  reports  are  far  from  illuminating,  if  made  at  all. 

In  the  consideration  of  government  and  municipal 
securities,  corporate  conditions  too  are  a  factor,  but 
of  a  different  type.  With  them  it  is  generally  a  question 
of  public  revenue — whether  a  large  tax  can  be  collected 
when  needed;  extent  and  richness  of  resources;  the 
quality  of  laws  extant.  United  States  Government 
bonds,  assisted  by  an  artificial  market,  sell  at  higher 
prices  to-day  than  those  of  any  other  government 
in  the  world  because  all  these  questions  may  be  satis- 
factorily answered.  The  confidence  of  the  world  has 
been  won  financially,  diplomatically,  and  politically. 

The  relative  effect  of  conditions  on  the  bond  market 
in  general  is  open  to  discussion,  and  indeed  can  never 


8o  Investment  Bonds 

be  definitely  measured.  Perhaps  the  strongest  in- 
fluence is  exerted  by  the  state  of  the  money  market. 
Though  not  coincident,  the  bond  market  and  money 
market  are  bound  together  in  close  association.  To 
understand  either  means  a  fundamental  knowledge 
of  the  other. 

"Tight"  money,  such  as  cannot  be  easily  obtained 
except  at  a  high  interest  rate,  and  "easy"  money,  eas- 
ily obtained  and  generally  at  a  low  rate,  affect  the 
bond  market  noticeably.  The  former — a  disgrace  to 
the  monetary  system  of  the  country,  as  many  bankers 
think — usually  comes  about  when  money  in  large 
volume  leaves  a  money  centre.  New  York,  in  par- 
ticular, suffers  each  autumn  when  the  need  of  currency 
for  crop-moving  is  supplied.  At  other  times  high 
money  is  caused  by  intense  activity  in  general  business. 
The  great  body  of  investment  capital  may  be  so  re- 
muneratively employed  in  active  business  as  to  absorb 
great  amounts.  Or,  again,  large  financial  transactions, 
involving  the  transfer  of  much  money,  may  produce 
the  same  effect. 

Naturally,  while  high  interest  rates  prevail  in  one 
place,  idle  funds  in  others  will  be  drawn  there,  the 
interest  return  on  bonds  offering  no  attraction.  So 
tempting  are  the  opportunities  sometimes  for  high 
rates  on  loans  that  bonds  are  thrown  into  the  market 
to  obtain  the  funds.  This,  with  the  low  ebb  of  invest- 
ment buying,  depresses  prices  and  reduces  transactions 
to  a  minimum.  A  direct  connection  therefore  is  evi- 
dent between  the  falling  off  of  bond  purchases  and 
-excessive  interest  rates.  Money  stringencies,  how- 
ever, are  essentially  local,  although  the  year  1907  will 
go  down  in  history  as  witnessing  this  condition  of 
affairs  almost  world-wide.  While  New  York  is  in  the 


Market  81 

throes  of  "tight"  money,  Chicago  may  be  enjoying 
easier  rates,  so  that  bond-buying  at  that  point  might 
not  be  seriously  and  directly  affected. 

Easing  of  money  rates  and  relaxation  in  general  busi- 
ness is  sure  to  be  reflected  in  the  bond  market.  Bankers 
begin  to  bid  for  new  issues ;  banks,  trustees,  and  investors 
begin  to  buy.  '  In  fact  low  money  rates  are  apt  to 
create  a  broad  demand  for  most  classes  of  securities. 
Not  only  do  such  interest  rates  enable  bankers  to  readily 
handle  large  blocks  of  securities,  but  this  stimulates 
the  demand  by  turning  all  idle  funds  into  bonds. 
Whether  these  funds  belong  to  savings  banks,  trust 
companies,  national  banks,  or  investors  they  thus  re- 
ceive a  better  return  than  is  afforded  by  the  money 
market.  With  surplus  funds  at  hand,  investors  every- 
where naturally  turn  to  bonds.  As  a  general  pro- 
position, "easy"  money  accompanied  by  prosperous 
conditions  throughout  the  country  induces  activity  in 
this  branch  of  the  general  market. 

The  other  branch,  the  stock  market,  is  likewise  sensi- 
tive to  the  fluctuations  in  money  rates.  In  a  measure, 
its  activities  are  responsible  for  the  rates.  Immense 
sums  are  required  to  finance  speculation,  establishing 
enormous  loan  accounts  and  absorbing  funds.  But  a 
decline  in  the  stock  market,  because  of  monetary  con- 
ditions, does  not  come  so  quickly  as  in  the  bond 
market.  Profits  from  share  investments  and  in 
speculation  for  the  rise  are  so  tempting  that  capital 
cannot  readily  be  drawn  into  the  market  for  long- 
term  loans  such  as  are  most  bonds.  Consequently, 
a  declining  bond  market  may  accompany  a  strong 
and  advancing  stock  market.  The  transition  which 
brings  this  about  is  generally  a  slackening  demand 
for  good  bonds  with  a  corresponding  increase  for  those 


82  Investment  Bonds 

of  a  speculative  character,  and  eventually  few  bonds 
at  all  and  largely  stocks.  Under  ordinary  circumstances, 
a  strong  investment  market  is  sometimes  the  precursor 
of  a  strong  stock  market,  but  they  often  move  in 
opposite  ways. 

While  this  is  reasonably  true  of  the  general  market, 
in  individual  cases  it  is  different.  Bonds  of  a  company 
generally  rise  and  fall  in  price  in  sympathy  with  its 
stock,  the  extent  being  largely  determined  by  the 
kind  of  bond  and  class  of  stock.  This  is  particularly 
noticeable  with  convertible  issues,  where  the  fluctua- 
tion is  in  correspondence  with  the  chances  of  profitable 
conversion.  Such  was  the  case  with  Atchison,  Topeka 
&  Santa  F6  bonds  not  long  ago.  In  one  day  alone, 
a  heavy  decline  in  price  occurred.  The  stock  run- 
ning down  from  io8f  to  103  J  induced  heavy  transac- 
tions in  that  company's  convertible  issue  and  the  price 
of  these  bonds  dropped  from  109  to  105!.  Underlying 
such  declines,  of  course,  are  special  reasons,  but  the  case 
is  typical  of  the  fact.  Again,  the  price  that  will  be  real- 
ized on  a  new  issue  is  apt  to  be  contingent  upon  the  price 
at  which  existing  securities  of  the  company  are  selling. 
With  the  stock  selling  at  high  figures,  the  inference  may 
be  safely  drawn  that  interest  on  the  new  bonds  will  be 
promptly  and  regularly  paid.  Announcement  of  a  bond 
issue  may  affect  the  stock  of  a  company  adversely.  It 
may  be  so  unpopular  a  procedure  with  some  of  the 
stockholders  as  to  cause  an  immediate  decline  in  the 
stock,  which  in  turn  would  affect  the  definitive  bonds 
when  issued. 

For  want  of  a  better  figure,  the  general  conditions 
which  seriously  affect  the  marketing  of  bonds  may  be 
likened  to  environment,  making  for  their  woe  or  weal. 
There  are  yet  others  to  reckon  with.  A  bond  issue  is 


Market  83 

a  success  as  much  because  of  what  it  is  as  because  of 
where  it  goes.  Perhaps  the  former  is  the  major  con- 
sideration— that  is  its  heredity. 

Analyzed  from  this  view-point,  as  it  always  is,  a 
number  of  considerations  come  quickly  to  the  fore. 
Many  times  these  are  the  governing  factors  in  the 
selection  of  a  bond.  Irrespective  of  technical  con- 
siderations, however,  some  investors  have  strong 
preferences.  Three  and  one  half  per  cent,  bonds,  for 
instance,  are  entirely  unpopular  with  private  investors, 
who  would  rather  pay  a  high  premium  on  a  four  per 
cent,  issue  because  of  its  greater  convenience  and 
better  marketability.  The  three  per  cent,  bond  is 
likewise  fast  disappearing.  Some  investors  will  con- 
sider only  railroad  bonds;  others  municipal  issues; 
while  still  others — and  these  constitute  by  far  the 
largest  class — will  purchase  any  security  the  safety 
and  desirability  of  which  are  demonstrated  to  their 
satisfaction. 

What  a  bond  is,  makes  desirability  and  contributes 
toward  its  safety.  Its  very  name  often  decides  this 
immediately;  such  names  as  debenture,  income,  and 
convertible  establish  the  identity  quickly  and,  of 
course,  make  their  own  market  largely.  The  name 
of  a  security  often  helps  sell  it  though  it  may  be  in- 
ferior to  some  other.  Inferentially  this  is  proved  by 
the  eagerness  everywhere  to  get  into  every  title 
possible  the  word  first — a  few  years  ago  first  and 
mortgage  were  the  magic  that  sold  almost  anything 
that  looked  like  a  bond. 

The  character  of  a  bond  as  to  its  speculative  or 
investment  nature  determines  its  market  largely. 
A  class  of  investors  readily  take  bonds  which  are 
considered  a  fair  commercial  risk.  They  prefer  to 


84  Investment  Bonds 

invest  in  something  like  junior  mortgages  or  conver- 
tibles ;  something  that  will  enhance  with  growth ;  some- 
thing of  not  the  highest  investment  character  and 
absolutely  secure  which  has  reached  its  full  apprecia- 
tion in  value.  Convertible  bonds,  for  this  reason,  are 
easily  sold,  hence  issued  largely.  So  long  as  these  invest- 
ors can  get  such  bonds  at  a  discount  they  will  not  buy 
many  first-class  securities  at  premium.  They  are  will- 
ing to  sacrifice  one  essential,  safety,  for  another,  profit. 

The  element  of  security  in  an  issue  often  differenti- 
ates its  holders  markedly.  Fiduciary  institutions,  for 
instance,  may  better  err  by  ultra-conservatism  in 
investments  than  take  undue  risks.  The  price  of  a 
bond  generally  varies  inversely  with  its  security;  the 
lesser  and  more  inferior  it  be,  the  lower  the  price. 
The  inferior  bond  may  sell  below  par  while  a  good 
first  mortgage  bond  of  the  same  company  and  at 
the  same  interest  rate  may  be  above  par. 

Of  prime  consideration  is  the  interest  rate  a  bond 
carries.  This  is  a  factor  in  the  determination  of  what 
the  bond  returns.  Old  line  and  institutional  investors 
may  wish  a  little  better  than  average  return  but  are 
apt  to  look  with  suspicion  upon  a  very  high  rate. 
Yet  in  this  does  the  question  resolve  itself  into 
others  such  as  individual  preference,  degree  of  security 
consistent  with  the  return,  etc.  Another  element 
affecting  return  and  consequently  affecting  the  market- 
ability of  a  bond  is  its  taxableness.  Other  things  being 
equal,  the  imposition  of  a  tax  is  a  material  influence  in 
narrowing  or  localizing  the  distribution  and  depressing 
the  price.  Fully  alive  to  this,  nearly  all  public  cor- 
porations issue  their  securities  tax-free.  Some  bonds 
are  issued  tax-exempt  in  certain  States  and  therefore 
are  particularly  desirable  in  those  States. 


Market  85 

The  element  of  time  is  involved  in  the  profits  from 
an  investment.  Many  investors,  especially  institu- 
tions, do  not  care  to  have  their  bonds  subject  to  ter- 
mination at  almost  any  time.  Their  investments  are 
made  to  hold.  They  prefer  to  be  able  to  calculate 
closely  net  return.  Therefore,  sinking  fund  provisions 
or  privileges  of  redemption,  rendering  uncertain  the 
life  of  a  bond,  work  to  its  detriment  and  this  feature 
of  undesirability  is  reflected  in  its  price.  In  part  ex- 
planation of  the  low  bids  the  Government  received  for 
the  recent  issue  of  Panama  bonds  is  the  fact  that 
many  considered  the  security  as  practically  a  ten- 
year  maturity  owing  to  the  redemption  privilege. 

The  credit  of  a  strong  company,  in  the  form  of 
guarantee,  back  of  the  bonds  of  one  less  strong  or 
subsidiary,  contributes  greatly  to  the  marketability 
of  those  bonds,  and  again,  any  special  privileges  ac- 
companying an  issue  assist  toward  this  end. 

A  full  development  of  each  of  the  foregoing  is  not 
necessary  to  show  the  reciprocal  effects  of  price  and 
distribution  in  the  bond  market.  Generally,  distribu- 
tion is  a  determinant  of  stability  or  fluctuation  in  price. 
Conversely,  bonds  just  around  par,  one  way  or  the 
other,  are  most  easily  sold  and  in  general  favor.  Fluc- 
tuation, however,  is  relative;  as  applied  to  U.  S.  Govern- 
ment issues,  wide  fluctuation  means  comparatively 
small  variation  in  price.  Changes  of  from  one  to  two 
points  within  a  short  period  would  be  considered 
unusual,  while  a  movement  of  ten  points  in  some 
speculative  issue  might  not  be  considered  extraordinary. 
On  the  whole,  bonds  do  not  fluctuate  like  stocks. 
The  bond  market  will  frequently  remain  at  about  one 
level  for  several  weeks. 

The  ever-changing  demand  for  bonds  is  at  least  at 


86  Investment  Bonds 

two  periods  of  the  year  peculiarly  augmented.  In 
January  and  July  great  sums  in  dividends  and  interest 
are  disbursed  to  investors.  Upwards  of  $175,000,000 
passes  in  this  form  each  January  in  New  York  City 
alone.  Reinvestment  of  this  naturally  stimulates  ac- 
tivity in  the  bond  market.  As  an  index  to  its  extent 
it  is  interesting  to  note  that  the  figures  of  the  New  York 
Stock  Exchange,  which  represent  only  a  fraction  of  all 
business,  will  show  total  sales  for  the  first  five  days 
of  some  years  largely  in  excess  of  the  average  for  many 
other  days. 

Up  to  this  point  we  have  given  weight  to  practically 
none  but  financial  considerations — money  market, 
security,  reinvestment  demand  etc.  Others  there  are 
that  cannot  be  ignored  in  a  study  of  the  subject. 
Prominent  among  these  is  the  prestige  given  certain 
classes  and  certain  issues  by  favorable  legislation. 
Making  a  bond  a  legal  investment  for  savings  banks, 
trust  funds,  etc.  enhances  its  value,  generally  to  the 
extent  of  premium,  and  establishes  a  special  demand. 
Bonds  that  are  legal  for  New  York  and  Massachusetts 
have  just  such  a  special  market.  Prohibitory  laws 
have  the  effect  of  restricting  the  market  for  some  bonds 
to  certain  localities.  Debenture  bonds,  for  instance, 
are  not  a  legal  investment  for  New  York  savings  banks, 
hence  a  large  issue  by  the  New  York,  New  Haven 
&  Hartford  R.  R.  about  two  years  ago  was  practically 
absorbed  by  the  New  England  market  alone. 

Political  conditions — international,  national,  and 
local — all  with  greater  or  less  force  affect  the 
bond  market.  International  affairs  have  a  far- 
reaching  effect  and  others  of  a  lesser  scope  are  less 
universal  in  their  effect.  Under  the  stress  of  war  the 
bonds  of  conflicting  nations  are  sure  to  suffer  in 


Market  87 

proportion  to  success  or  defeats.  In  1905,  disasters 
suffered  by  Russia  caused  an  average  decline  of  20  per 
cent,  in  her  issues.  Immediately  after  the  fall  of 
Port  Arthur,  Russian  45  of  1889  were  quoted  at  91 J 
while  Japanese  43  stood  at  76  J,  a  difference  of  nearly 
fifteen  points  in  favor  of  the  Russian.  After  the 
battle  of  Mukden  and  the  destruction  of  the  Baltic 
fleet  the  Japanese  securities  had  drawn  level  with  the 
Russian.  Shortly  after  peace  was  firmly  established, 
the  Japanese  45  advanced  to  92^,  making  a  gain  of  six- 
teen points.  Later  the  development  of  internal  revo- 
lution and  forcible  dissolution  of  the  Duma  were  factors 
in  forcing  the  securities  of  Russia  to  low  levels. 

In  Great  Britain  the  quotations  for  consols  are 
regarded  as  a  fair  barometer  of  international  affairs. 
Any  improvement  in  the  aspect  of  foreign  politics  is 
sure  to  be  felt  in  that  direction.  In  our  own  country, 
the  result  of  a  Presidential  election  is  a  prime  factor. 
The  re-election  of  President  Roosevelt  in  1904  brought 
into  the  bond  market  great  numbers  of  investors  who 
had  waited  for  some  weeks  until  the  result  was  known. 
When  the  silver  question  was  up  in  1896,  just  before 
election  day  New  York  City  could  not  sell  an  issue  be- 
cause of  low  bids.  One  week  after  that  day,  an  accu- 
mulated batch  of  over  sixteen  million  was  ten  times 
oversubscribed  and  at  satisfactory  prices.  Local  condi- 
tions sometimes  have  a  depressing  effect  on  investors. 
Municipal  ownership  agitation  in  New  York  City  in 
times  past  was  considered  largely  responsible  for  the 
depreciation  of  its  securities  and  the  low  prices  bid  for 
new  issues. 

Since  the  expansion  and  contraction  of  the  bond 
market  is  the  reflex  of  conditions,  financial,  political, 
economic,  and  social,  it  follows  that  the  wider  the  dis- 


88  Investment  Bonds 

tribution  the  less  baneful  their  effect  on  a  bond  issue. 
Every  banker  is  conscious  of  the  fact  that,  generally 
speaking,  the  more  holdings  are  concentrated  the 
greater  the  possibility  for  ill  under  adverse  conditions. 
He  therefore  seeks  primarily  to  establish  as  wide  a 
market  as  possible.  The  desired  achievement  in  this 
respect  is  to  create  an  international  demand,  in  the 
•  accomplishment  of  which  banking  and  diplomacy 
often  go  hand  in  hand. 

A  distinct  feature  of  the  bond  market  for  several 
years  past  has  been  the  growth  of  the  American  de- 
mand for  foreign  issues  (practically  all  government) 
and  the  European  call  for  American  bonds.  Inter- 
national investment  of  capital  is  progressing  on  an 
enormous  scale  and  at  a  more  rapid  rate  than  ever. 
Foreign  government  issues  have  been  quoted  to  in- 
vestors in  this  country  for  some  years,  but  not  until 
comparatively  recently  has  any  real  interest  in  them 
been  awakened.  Exactly  the  same  is  true  of  Ameri- 
can investments  in  Europe. 

The  increasing  attention  our  financiers  are  paying 
to  South  American  finance,  both  national  and  private, 
and  the  growing  disposition  of  the  investing  public 
to  consider  foreign  issues  are  significant.  The  large 
Cuban  issue  was  eminently  successful,  perhaps  because 
of  the  measure  of  protection  afforded  to  investors.  The 
Mexican  loan  payable  in  gold  dollars  was  taken  some- 
what in  the  United  States.  British  consols,  French 
rentes,  and  German  marks  are  all  quoted  and  dealt  in 
here.  Consols  were  held  in  some  quantity  by  Ameri- 
can banks  because  of  their  liquidity  as  an  asset,  but 
their  declining  price  has  made  them  unattractive  to 
such  institutions. 

We   are,  however,  beginning   to   be   more   or   less 


Market  89 

intimate  with  the  government  finances  of  many  other 
nations.  We  no  longer  think  of  United  States  Govern- 
ment bonds  alone  when  we  speak  of  government  se- 
curities. Our  relation  to  Japanese  finance  has  already 
assumed  considerable  proportions  and  the  way  in 
which  the  Japanese  bonds  were  taken  by  investors 
and  various  financial  institutions  surprised  even  the 
bankers  that  handled  them. 

New  York  has  come  decidedly  to  the  fore  as  a  world 
bond  market ;  it  now  handles  yearly  millions  of  securi- 
ties of  other  nations.  It  has  assumed  a  world-wide 
importance  in  this  respect. 

American  securities  in  Europe  are  ever  gaining  a 
stronger  foothold.  While  Europeans  have  held  our 
securities  ever  since  the  Civil  War  there  now  seems  to 
be  a  marked  revival  of  interest.  Englishmen  are  taking 
more  and  more  bonds  as  they  find  their  home  field  of 
investment  becoming  restricted  and  they  have  devel- 
oped a  profound  faith  in  the  generally  sound  position 
of  American  industrial  and  financial  affairs.  In  Lon- 
don there  is  a  large  and  growing  market.  Indeed  that 
is  the  place  where  whole  issues  of  American  debentures 
find  absorption,  since  that  form  of  obligation  is  more 
in  vogue  in  England  than  here. 

In  France,  a  burdensome  government  tax  precludes 
the  possibility  of  extensive  investment  in  American 
bonds,  to  which  are  added  other  requirements  that  are 
restrictive.  To  be  legal  there,  securities  must  be 
listed,  involving  a  second  tax,  and  the  issuing  company 
must  maintain  an  office  in  France.  In  the  case  of  the 
Pennsylvania  loan,  these  obstacles  were  overcome 
largely.  The  securities  were  not  put  out  as  bonds  of 
the  Pennsylvania  R.R.  but  as  bonds  of  a  French  in- 
vestment company,  which  latter  were  secured  by  the 


90  Investment  Bonds 

deposit  of  the  former  as  collateral — in  this  way  the 
laws  were  evaded. 

Germany  holds  a  favorable  attitude  toward  Ameri- 
can securities  and  buys  to  the  extent  of  her  available 
capital.  Some  thirty  bond  issues  are  listed  in  Berlin 
and  the  investment  demand  is  comparatively  strong 
where  a  good  yield  may  be  derived.  The  large  banks 
are  educating  the  people  more  and  more  in  favor  of 
American  bonds. 

But  the  best  field  abroad  for  such  bonds  is  Holland. 
For  more  than  fifty  years  Dutch  investors  have  been  ac- 
cumulating until  now  the  total  is  close  to  $800,000,000 ; 
they  buy  in  greater  proportion  than  any  others  in 
Europe.  Bonds  that  are  sold  in  Holland  usually 
remain  there  as  investments  although  there  is  more  or 
less  trading  in  other  kinds  of  securities.  Little  buying 
is  done  by  other  nations,  but  there  is  a  widespread 
interest  developing  that  augurs  great  things  for  the 
future. 


CHAPTER  VIII. 

HOLDINGS. 

To  be  told  that  a  billion  dollars  par  value  of  bonds, 
a  veritable  plethora,  is  put  into  the  market  each  year 
is  to  severely  tax  the  comprehension.  Where,  pos- 
sibly may  be  asked,  can  such  a  stupendous  amount 
of  these  securities  alone,  not  to  mention  any  others,  find 
investors?  At  first  thought  it  seems  an  impossibility, 
but  under  the  light  of  some  analysis  it  becomes  plainly 
evident  where  they  find  lodgment. 

Complete  statistics  are  unobtainable,  but  several 
excellent  books  are  published  annually  that  serve  as 
a  guide  to  the  financial  community.  Still  the  magni- 
tude of  the  task  of  compilation  of  such  figures  and 
their  ever-changing  totals  quickly  render  them  of  more 
or  less  relative  value  only.  These  publications  classify 
according  to  the  name  of  a  given  security  all  bonds 
held  by  savings  banks,  trust  companies,  insurance 
companies,  and  other  financial  institutions  as  rendered 
annually  in  the  official  reports  made  to  the  different 
State  authorities,  and  designate  by  groups  the  leading 
banks  and  financial  institutions  which  have  purchased 
a  given  class  of  securities.  Such  reports  are  readily  ac- 
cessible, since  State  banks,  savings  banks,  trust  com- 
panies, etc.,  report  to  State  commissioners  appointed 
for  the  purpose,  while  national  banks  are  responsible 
to  the  Comptroller  of  Currency. 

91 


Q2  Investment  Bonds 

Holders  of  securities  are  of  two  kinds,  institutional 
and  individual;  the  former  buy  with  other  people's 
money — the  latter  with  their  own.  It  is  commonly 
believed  that  the  former  comprise  the  greater  portion 
of  the  market  and  that  individual  holdings  are  com- 
paratively light.  On  this  point,  in  speaking  of  the 
Wall  Street  bond  market,  the  Wall  Street  Journal 
has  to  say: 

The  tendency  of  bond  market  critics  is  to  magnify  the 
importance  of  the  institutions  and  minimize  the  importance 
of  individuals  to  buy  bonds.  When  it  comes  to  a  question 
of  aggregates,  the  institutions  take  second  place  to  the 
individual.  Out  of  the  $3,000,000,000  or  so  of  bonds 
floated  during  the  past  five  years,  it  is  probably  safe  to 
say  that  the  scattered  individual  public  has  bought  over 
$2,000,000,000,  while  banks,  trust  companies,  and  invest- 
ment institutions  have  taken  about  half  that  amount. 
The  aggregate  of  all  bonds  and  stocks  held  as  investments 
by  the  banks  and  trust  companies  of  the  United  States 
in  1907  was  about  $4,500,000,000. 

The  individual  investor  buys  in  small  lots,  compara- 
tively speaking.  Occasionally  the  executor  of  an  estate 
will  have  $1,000,000  or  over  to  put  into  bonds,  but  this 
is  the  exception  rather  than  the  rule.  The  average  buyer 
in  Wall  Street  is  probably  the  man  who  buys  from  five  to 
fifteen  bonds,  pays  for  them,  and  takes  them  away.  It  is 
this  class  that  buys  a  very  large  part  of  the  huge  issues 
floated  through  the  Wall  Street  market. 

Whatever  may  be  the  importance  of  the  individual 
investor,  it  cannot  be  gainsaid  that  institutions  are 
a  great  factor.  The  character  of  this  corporate  in- 
vesting and  the  relative  importance  of  each  class  of 
institution  is  interesting. 

Undoubtedly  the  insurance  business,   as  a  whole, 


Holdings  93 

constitutes  the  largest  single  market  for  high-grade 
securities  that  the  country  affords.  It  is  a  class  of 
corporations  comprised  of  fully  seventy-five  different 
types — life,  fire,  accident,  guarantee,  and  a  host  of 
others,  whose  basis  of  security  against  loss  is  bonds  to  a 
very  large  extent.  They  hold  some  of  nearly  every  kind 
but  chief  among  their  investments  are  railroad  bonds. 
Using  the  best  available  figures  as  a  basis,  it  is  safe 
to  say  their  aggregate  holding  of  railroad  bonds  is 
more  than  $1,000,000,000.  A  poor  second  in  total 
come  State  and  municipal  issues,  of  which  approxi- 
mately $150,000,000  is  held,  while  government  bonds 
both  home  and  foreign  fall  far  below  these  amounts ; 
$25,000,000  would  cover  the  entire  holdings  of  United 
States  Government  issues  and  something  less  those 
of  foreign  origin. 

Concentration  of  these  institutions  in  the  East 
naturally  puts  their  home  States  in  the  lead  when 
bulk  is  considered.  Being  the  domicile  of  the  three 
great  life  companies,  New  York  takes  first  place; 
following  which  and  of  about  equal  importance  are 
Pennsylvania  and  Connecticut,  with  Massachusetts  a 
good  third,  and  the  other  New  England  States  come 
on  in  more  or  less  uncertain  order. 

As  a  factor  in  the  investment  market,  savings  banks 
are  second  only  to  insurance  companies.  These  reser- 
voirs of  a  multitude  of  small  accounts  absorb  great 
masses  of  securities.  Here,  too,  New  York  leads,  Con- 
necticut being  second,  and  the  other  New  England 
States  and  Pennsylvania  following.  The  character 
of  their  business  requires  a  combination  of  well-nigh 
absolute  security  with  fair  return;  hence,  bonds  yield- 
ing but  a  small  income,  notwithstanding  their  safety, 
cannot  be  largely  among  their  investments. 


94  Investment  Bonds 

For  many  years  the  strength  of  a  savings  bank  was 
judged  by  the  amount  of  " governments"  it  held,  by 
reason  of  their  absolute  security,  value  as  quick  assets, 
and  fair  interest  yield.  In  the  last  few  years  con- 
ditions have  been  changing ;  the  unprofitable  yield  and 
the  tremendous  commercial  and  railway  development 
of  the  last  decade  have  made  bonds  of  this  latter 
character  good  investments.  Analysis  of  the  reports 
of  many  savings  banks  shows  a  great  tendency  to 
decrease  the  holdings  of  "governments."  In  fact, 
it  will  be  found  that  some  of  the  strongest  institutions 
have  sold  all  bonds  of  this  nature  and  reinvested  the 
proceeds  in  other  securities  of  merit,  ready  market, 
and  good  income. 

Ten  years  ago  the  combined  investments  of  savings 
banks  of  the  country  in  United  States  bonds  were  not 
less  than  $150,000,000.  Ten  years  ago  these  insti- 
tutions in  New  York  State  counted  among  their  in- 
vestments $111,000,000  of  U.  S.  bonds;  to-day  they 
hold  of  this  particular  class  of  securities  less  than 
$15,000,000  and  in  the  same  period  they  have  increased 
their  ownership  of  railway  bonds  from  practically 
nothing  to  $2  50,000,000.  The  same  ratio  holds  through- 
out the  country,  for  what  New  York  does,  they  all  do. 

State  laws  rather  discriminate  in  favor  of  municipal 
bonds  as  proper  investments  for  savings  banks,  the 
evidence  of  which  is  clearly  seen  in  holdings  of  this 
nature.  New  York  savings  banks,  for  instance,  hold 
approximately  $400,000,000  of  State  and  municipal 
obligations,  of  which  fully  $125,000,000  are  of  New  York 
City.  Thus  is  it  that  these  laws  affecting  their  invest- 
ments have  a  marked  effect  on  holding  of  bonds  both  as 
to  character  and  extent.  Statutes  of  different  States 
vary  greatly  in  respect  to  permission  of  investment; 


Holdings  95 

some  are  stringent,  others  liberal :  some  prescribe  general 
qualifications,  other  are  specific;  some  laws  definitely 
name  the  cities  whose  bonds  may  be  held,  while 
others  state  general  qualifications  as  to  population,  etc. l 
As  new  avenues  of  investment  are  opened  the  laws  of 
many  States  are  constantly  amended,  being  made 
broader  in  their  provisions  and  standardizing  in 
their  qualifications.  In  proof  of  this  is  the  fact 
that  barely  ten  years  ago  these  institutions  were 
quite  generally  not  allowed  to  purchase  railroad  bonds. 

In  point  of  restriction  of  investment  the  laws  of 
New  York  State  are  the  most  rigid  of  any  State  in  the 
Union  in  the  interest  of  safety.  Limited  by  law  to 
gilt-edged  governmental  securities,  real  estate  mort- 
gages, and  first-class  railroad  bonds,  New  York  banks 
are  shut  off  from  many  sources  of  revenue  open  to 
similar  institutions  in  other  States.  In  Massachusetts, 
for  instance,  street  railway  securities  are  approved. 
Particularly  strong  in  contrast  is  the  State  of  Pennsyl- 
vania, whose  savings  banks  are  often  referred  to  as 
earning  such  large  amounts  as  would  invite  subjec- 
tion of  earnings  to  taxation.  A  Pennsylvania  savings 
bank  has  legal  power  to  invest  funds  of  depositors 
in  the  bonds  of  any  city,  county,  town,  or  village  in 
the  United  States,  regardless  of  debt  limit  or  record 
as  to  repudiation.  Very  few  of  the  western  and  central 
states  put  any  close  restrictions  upon  the  trustees  of 
their  banks. 

The  loss  of  earning  power  to  the  New  York  banks 
is  the  gain  of  the  depositor  in  safety,  and  recognition 
that  a  savings  bank  must  first  of  all  safeguard  its  funds, 
rather  than  conduct  itself  as  a  purely  profit-earning 

1  For  synopsis  of  these  laws  see  Commercial  and  Financial 
Chronicle. 


96  Investment  Bonds 

enterprise,  involves  a  further  recognition  that  the 
greatest  economic  force  operating  to-day  is  that  of  the 
savings  banks. 

National  banks  occupy  a  distinctive  and  peculiar 
position  in  the  field  of  investment.  As  holders  of 
upwards  of  seventy-five  per  cent,  of  the  outstanding 
issues  of  our  Government,  they  constitute  a  special 
market,  a  situation  brought  about  more  from  necessity 
than  choice. 

In  the  first  place,  such  a  bank  cannot  obtain  its 
charter  unless  United  States  Government  bonds  to 
the  amount  of  twenty-five  per  cent,  of  its  proposed 
capital  stock  up  to  $150,000,  and  $50,000  as  a  minimum 
when  the  capital  is  greater,  are  deposited  in  the  Treas- 
ury. Obviously,  then,  a  constant  demand  of  no  in- 
considerable proportion  exists  because  of  the  increasing 
number  of  such  institutions.  Many  of  these  new 
banks  proceed  at  once  in  what  is  generally  done  by 
those  already  established — the  issue  of  notes,  i.  e., 
circulation,  all  of  which  must  be  secured  at  Washington 
by  the  pledge  of  Government  bonds.  Furthermore, 
when  any  receive  deposits  of  public  funds  from  the 
Government,  bonds  to  the  amount  obtained  must  be 
pledged  with  the  Government. 

Of  themselves,  these  three  sources  of  demand  are 
sufficient  to  care  for  immense  quantities  of  bonds,  but 
like  the  other  institutions,  these  banks  put  some  of 
their  funds  into  straight  investments,  which  further 
augments  the  demand.  Such  investments  in  Govern- 
ment bonds,  of  course,  are  comparatively  old,  but 
within  the  past  few  years  national  banks  have  become 
more  largely  than  ever  holders  of  bonds  of  different 
types.  What  prompts  this  buying  varies  with  different 
banks.  The  appearance  of  a  substantial  bond  item 


Holdings  97 

in  a  bank's  statement  has  its  effect  sentimentally;  in 
many  people  it  begets  a  greater  confidence  in  the  bank. 
Many  banks  carry  some  bonds  as  a  secondary  reserve, 
preferring  to  hold  a  percentage  of  bonds  as  a  precau- 
tion of  safety  rather  than  loan  on  commercial  paper 
to  the  extent  of  their  abilities,  while  others  have  none 
at  all.  They  are  divided  in  their  opinions  as  to  the 
relative  desirability  of  holding  bonds  or  commercial 
paper  as  quick  assets. 

As  a  general  rule,  the  less  important  a  bank  is  among 
financial  institutions  the  greater  the  bond  holdings, 
the  large  and  powerful  banks  in  the  cities  holding 
proportionately  few,  using  their  funds  in  different  ways. 
It  has  been  estimated  that  holdings  of  such  "bond 
reserves"  are  well  around  $500,000,000. 

There  has  been  an  enormous  growth  of  trust  com- 
panies within  the  past  few  years  and  with  their  growth 
absorption  of  hundreds  of  millions  of  bonds.  Except 
in  a  few  States,  they  are  under  little  restriction  of  law 
as  to  their  investments,  in  striking  contrast  with  the 
strict  supervision  of  savings  and  national  banks.  The 
effect  of  this  is  quickly  seen  in  comparison  of  their 
investments  with  those  of  savings  banks.  New  York 
State  trust  companies  hold  approximately  $300,000,- 
ooo  of  stocks  and  hardly  more  than  $100,000,000  of 
bonds.  Even  so,  this  is  fully  fifty  per  cent,  of  the 
bond  investments  of  all  trust  companies  in  the  country. 
In  this  State  their  capitalization  may  consist  of  Govern- 
ment, State,  and  Municipal  bonds,  but  only  ten  per 
cent,  of  it  must  be  deposited  in  such  form  with  the 
State  Comptroller.  In  New  York  City,  where  are 
located  the  majority  and  strongest  of  the  one  hundred 
or  so  trust  companies  of  the  State,  one  third  of  the 
reserve  of  fifteen  per  cent,  of  deposits  must  be  in  bonds. 


98  Investment  Bonds 

Still  other  institutions  must  be  considered — build- 
v  ing  and  loan  companies,  colleges  and  institutions  of 
learning,  etc.  Endowments  of  educational  corporate 
bodies  are  almost  entirely  represented  by  securities, 
generally  bonds,  nearly  half  of  which  are  railroad 
issues.  Add  together  the  great  number  of  these  scat- 
tered throughout  the  country  and  the  aggregate  of 
their  endowments  mounts  high  into  the  millions  of 
nine  figures. 

In  the  group  of  universities  Harvard,  Yale,  Chicago, 
and  others  are  to-day  endowed  in  amounts  from  $18,- 
000,000  to  $25,000,000  each,  while  Leland  Stanford  of 
California  lays  claim  to  possibly  $45,000,000.  Many 
of  the  smaller  colleges  are  proportionately  as  well 
provided  for. 

From  these  incomprehensible  figures  it  would  seem 
that  institutional  investments  far  outweigh  the  private, 
nevertheless  so  excellent  an  authority  as  the  paper 
quoted  is  difficult  of  contradiction.  Certain  it  is,  how- 
ever, that  a  great  mass  of  people  of  small  means  and 
limited  income  put  their  savings  into  life  insurance 
and  savings  banks,  thus  leaving  to  others  as  institu- 
tions the  investing  of  funds  thus  concentrated. 

The  fact  that  the  great  and  strong  fiduciary  and 
financial  institutions  are  nearly  all  located  in  the 
eastern  part  of  the  country  has,  of  course,  a  vital 
bearing  on  the  bond  market,  geographically  considered. 
Proportionate  holdings  are  by  no  means  the  same  all 
over  the  country,  some  localities  holding  much  more 
than  others.  Economic  conditions  account  for  this. 
Manufacturing  states  (which  are  the  eastern)  are  the 
great  security-holders,  while  the  strictly  agricultural 
states  are  almost  a  negligible  factor.  It  is  true  the 
juxtaposition  of  financial  centres  and  the  industrially 


Holdings  99 

developed  portions  has  much  to  do  with  it.  Institu- 
tional investing  in  the  agricultural  regions  is  at  a 
minimum;  it  would  be  useless  to  invest  in  bonds  in  a 
developing  portion  of  the  country  where  money  can  be 
loaned  at  anywhere  from  six  to  ten  per  cent.  In  semi- 
developed  interior  sections  demand  for  bonds  is  felt 
somewhat,  since  their  banks  are  not  always  able  to 
loan  all  accumulating  funds. 

Locality  not  only  affects  the  extent  but  also  the 
character  of  holdings.  Although  unimportant,  it  is 
interesting  to  know  that  a  goodly  portion  of  the  Ameri- 
can market  for  foreign  bonds  is  among  foreigners. 
In  a  community  of  certain  nationalities  bankers  will 
generally  hold  some  bonds  of  the  home  country,  which 
find  a  more  or  less  ready  distribution. 


CHAPTER  IX. 

INTEREST. 

ONE  of  the  fundamental  distinctions  of  finance,  that, 
strange  to  say,  must  yet  be  learned  by  many,  is  the 
difference  between  interest  and  dividend.  Such  ig- 
norance as  to  confuse  annuity  with  interest  is  even 
met.  Lest  the  distinctions  be  not  clear  it  should  be 
said  that  interest  is  but  the  representation  of  cost  to 
a  borrower  for  the  privilege  of  using  another's  funds. 
The  "price  of  money"  is  an  idiomatic  expression  of 
Wall  Street  for  the  situation.  Dividend,  so  different 
in  nature,  is  a  profit  accruing  to  the  owners  of  the 
business,  and  is  distributed  pro  rata.  Vitally  different 
from  either,  and  arising  out  of  transactions  unlike  the 
above,  a  pure  annuity  is  a  sum  of  money  payable 
yearly,  to  continue  for  a  given  number  of  years,  for 
life,  or  forever. 

Many  kinds  of  financial  transactions  involve  the  pay- 
ment of  interest,  but  it  is  with  the  bondholder, 
as  a  creditor  of  a  corporation,  that  we  are  concerned. 

There  is  yet  another  distinction,  most  important  of 
all,  to  be  remembered.  Thousands  who  hold  bonds 
are  under  the  misconception  that  the  rate  of  interest 
indicated  on  their  bond  represents  their  return;  if  it 
is  a  five  per  cent,  issue,  so  much  they  receive.  Bought 
at  par,  this  would  be  true,  but  probably  more  was 
paid.  The  average  investor  knows  not  overmuch 
about  yield  and  so  is  not  always  aware  that  the  net 

100 


Interest  101 

return  on  a  bond  is  not  always  as  great  as  the  rate  of 
interest  which  the  bond  bears.  Should  a  bond  be 
purchased  above  par  it  is  at  a  premium — below  par  it 
is  at  a  discount:  the  former  decreasing,  the  latter  in- 
creasing the  yield  from  the  interest  rate.  Computa- 
tion of  yield  is  an  involved  mathematical  process. 
This  yield  or  net  return  is  generally  known  as  the 
"basis"  and  bonds  are  spoken  of  as  selling  on  a  two, 
three,  or  four  per  cent,  basis  or  whatever  the  figure 
may  be. 

On  the  great  majority  of  bonds  the  interest  rate  is 
definite ;  the  contract  is  for  so  much  annually — no  more, 
no  less — during  the  life  of  the  obligation ;  it  is  fixed  and 
must  be  paid.  All  others  may  be  said  to  carry  con- 
tingent and  indeterminate  interest  according  to  circum- 
stances. These  circumstances  are  generally  the  result 
of  arrangement  or  of  success  or  ill-success  of  the  issuing 
corporation.  Few  types  of  bonds  fall  into  this  cate- 
gory, the  most  prominent  being  income  bonds.  On 
this  type  of  obligation  it  remains  ever  contingent  and 
is  so  provided  in  the  bond. 

With  this,  as  noted  in  our  classification,  payment  of 
interest  varies  in  time  and  often  in  amount,  although 
its  maximum  is  stated.  In  effect  it  is  equivalent  to 
a  dividend,  since  it  is  dependent  upon  the  earnings 
and  paid  only  if  earned.  Yet  it  cannot  be  correctly 
so  called.  References  to  it  as  such,  as  found  in  the 
following  quotation  from  a  recent  financial  paper,  are 
misleading:  "The  directors  of  the  corporation  have 
authorized  an  initial  dividend  of  five  per  cent,  on 
its  $3,000,000  of  income  bonds,  payable  out  of  the 
earnings  of  the  year  ended  June  3oth,  1907." 

Division  of  large  issues  whose  interest  is  conditional 
into  series  such  as  A,  B,  C — i,  2,  3,  often  enables  pay- 


102  Investment  Bonds 

ment  of  interest  on  the  earlier  ones  if  not  on  all.  The 
old  debentures  of  the  Wabash  Railroad  were  a  case 
in  point;  interest  was  sometimes  paid  on  series  "A" 
only.  Further  illustration  is  found  in  the  incomes  of 
the  Georgia  Central  Railway;  although  all  series  are 
entitled  to  five  per  cent,  interest,  the  firsts  may  receive 
their  full  amount  while  the  seconds  only  one  or  two 
per  cent.,  and  the  thirds  nothing.  If  the  management 
of  a  corporation  has  great  faith  in  its  growth  and  earn- 
ing ability  income  bonds  may  carry  cumulative  inter- 
est, but,  as  a  general  rule,  provisional  interest  is  not 
made  cumulative  on  incomes. 

There  are  at  present  not  a  few  bonds  whose  interest 
has  been  ''scaled."  Out  from  the  fires  of  reorganiza- 
tion, their  holders  have  been  glad  to  accept  the  best 
terms  possible.  At  such  times  it  is  generally  found 
necessary  to  cut  down  interest  somewhere,  but  the 
pruning  must  not  be  more  than  sufficient  for  successful 
operation.  A  nice  discrimination  between  the  issues 
of  a  property  is  therefore  necessary  that  justice  may 
be  done.  By  agreement  between  the  company  and  a 
majority  of  the  holders  reduction  is  occasionally  made 
for  a  term  of  years,  with  return  to  the  old  rate  there- 
after; but  permanent  reduction  is  the  usual  course. 

The  position  of  interest  charges  in  the  finances  of  a 
corporation  brings  about  the  reductions  in  reorganiza- 
tion. Chief  among  fixed  charges  and  payable  before, 
dividends,  it  is  obvious  they  must  be  reduced  within 
a  conservative  estimate  of  net  earnings  to  make  the 
property  a  going  concern  once  more. 

How  great  an  item  the  fixed  charges  of  interest  are 
may  be  inferred  from  the  fact  that  interest  on  all  rail- 
road bonded  indebtedness  in  this  country  approximates 
$250,000,000  annually.  This  covers  fairly  well  the 


Interest  103 

entire  debt  of  this  class,  as  hardly  more  than  one 
twentieth  of  the  bonded  indebtedness  pays  no  interest 
at  the  present  day.  Expressed  in  percentage  of  in- 
come, this  aggregate  interest  charge  represents  about 
fifteen  per  cent.,  over  against  which  is  about  nine  per 
cent,  paid  to  the  owners  in  dividends. 

Interest  payments  on  municipal,  Government,  and 
other  bonds  are,  of  course,  enormous,  Government 
bonds  alone  calling  for  the  disbursement  of  something 
like  $30,000,000  yearly. 

These  great  sums  are  derived  in  ways  entirely  in 
keeping  with  the  nature  of  a  corporation  and  its  busi- 
ness. The  Government  has  numerous  sources  of  in- 
come, chief  of  which  is  receipts  from  custom  duties, 
a  form  of  indirect  taxation;  municipal  corporations 
must  necessarily  derive  the  bulk  of  their  income  from 
direct  and  general  taxation.  There  are,  however, 
some  municipal  obligations  for  the  payment  of  which 
specific  revenues  are  pledged  and  which  do  not  fall 
as  a  direct  burden  on  taxpayers.  Income  from  docks f 
for  instance,  may  produce  a  net  return  equal  to  interest 
on  the  bonds  and  provide  fully  for  a  sinking  fund  for 
their  retirement ;  again  interest  of  water  bonds  is  pro- 
vided by  water  rents.  There  are  also  many  issues  whose 
interest  is  provided  by  special  assessment  limited  to 
one  locality. 

Railway,  industrial,  and  miscellaneous  corpora- 
tions must  gain  the  necessary  funds  from  the  opera- 
tions and  profits  of  business  and  sometimes  at  the 
expense  of  betterments  and  improvements.  In  the 
railway  field,  the  particular  portion  of  the  line 
which  an  issue  may  cover  must  produce  its  inter- 
est. Traffic  agreements,  ad  infinitum,  are  made  with 
branch  and  subsidiary  lines  whereby  interest  on 


104  Investment  Bonds 

their  bonds  is  provided.  In  some  cases  a  road  is 
allowed  to  enter  another's  terminal  on  payment  of 
interest  on  the  station  bonds;  in  other  instances  this 
terminal  bond  interest  is  paid  pro  rata  by  the  entering 
roads  on  a  per  train  basis. 

The  great  bulk  of  all  bond  interest  is  disbursed  semi- 
annually,  much  of  it  on  an  early  date  of  January  and 
July  coincident  with  the  publication  of  financial  state- 
ments of  most  corporations.  The  fiscal  year  being 
from  July  to  July  it  is  largely  a  matter  of  convenience 
to  use  those  dates.  A  few  pay  interest  in  April  and 
October  and  some  pay  interest  quarterly.  The  U.  S. 
Government  pays  all  its  issues  quarterly.  It  is  a  matter 
entirely  optional  with  the  issuing  corporation.  Also 
how  and  where  it  shall  be  paid  is  not  governed  by  any 
strict  rule.  The  character  of  the  bond,  whether  cou- 
pon or  registered,  determines  this  in  some  measure. 
Since  the  centre  of  the  bond  market  is  New  York  City, 
it  is  only  natural  that  investors  should  be  enabled  to 
receive  interest  with  some  facility  and  convenience. 
For  this  reason  most  corporations  maintain  a  fiscal 
agency  in  that  city  with  a  trust  company,  bank  or 
banking  house.  Kansas  and  practically  all  its  minor 
civil  divisions  make  their  bonds  payable  at  one  bank 
in  New  York. 

Issues  taken  locally,  away  from  New  York,  of  course 
are  paid  at  home.  Often  two  or  more  places  are  desig- 
nated as  where  interest  will  be  paid ;  a  town  in  Colorado 
might  pay  at  New  York,  Chicago,  and  home.  Es- 
pecially is  this  the  case  where  a  bond  has  an  inter- 
national market.  Funds  are  kept  in  the  various 
financial  centres  to  meet  these  periodic  demands  and 
it  is  generally  stipulated  that  payments  will  be  made 
at  fixed  or  current  rate  of  exchange. 


Interest  105 

Registered  bonds  are  always  paid  by  check  sent  * 
from  the  home  office.  Ordinary  coupons  are  usually 
presented  in  an  envelope  on  which  is  shown  the  name 
of  the  security  and  name  of  the  person  or  institution 
presenting  same,  and  upon  verification  are  paid. 
Registered  coupon  issues  are  often  made  payable 
only  to  the  order  of  the  registered  owner. 

Where  the  bond  is  registered,  the  books  of  record 
are  closed  for  a  certain  period ;  that  is,  no  transfers  are 
made  during  that  time.  The  holders  of  record  on  a 
specified  date  would  receive  the  amount  of  interest 
on  the  bond  in  question.  The  Government  books 
close  one  month  before  interest  is  payable.  Should 
a  bond  be  negotiated  during  this  period,  the  seller 
will,  of  course,  receive  the  check,  but  the  trade  may 
be  so  made  that  it  is  turned  over  to  the  purchaser,  or 
it  may  be  made  ex-interest. 

Until  comparatively  recently,  the  rate  of  interest 
on  investments  has  steadily  declined;  the  day  of  very 
large  returns  on  securities  offered  to  the  general  public 
is  over.  For  more  than  a  quarter  of  a  century  the 
value  or  earning  power  of  money  has  been  gradually 
declining  toward  the  European  level.  During  these 
years  this  constantly  lowering  interest  rate  has  been 
the  discussion,  reference  being  made  to  England  and 
the  continental  countries  of  Europe  and  the  position 
which  they  occupy  in  this  particular.  This  argument 
was  made  with  some  force  by  the  insurance  companies 
when  being  investigated  in  1905;  their  attempt  was 
to  show  that  3  or  3  \  per  cent,  is  the  most  that  could  be 
earned  on  deposited  premiums. 

As  a  matter  of  fact,  there  has  been  a  steadily  declining 
plane  of  interest  for  some  years  back;  but,  simultaneous 
with  a  higher  rate  that  is  now  being  reached  in  the 


io6  Investment  Bonds 

older  countries,  there  is  something  of  an  upward  turn 
in  the  rates  for  long-time  loans  in  this  country — the 
low  point  of  net  income  has  apparently  been  reached. 
The  German  Government  only  recently  made  its  in- 
terest rate  officially  3 \  per  cent,  whereas  for  some  years 
past  it  had  been  3  per  cent. 

The  fact  that  interest  rates  are  being  gradually 
raised  on  some  classes  of  bonds  emphasizes  the  growing 
tendency  of  investors  to  demand  a  larger  income  from 
their  investments  than  has  satisfied  them  in  the  past. 

Insurance  companies,  savings  banks,  and  others 
will  hardly  take  less  than  from  3.80  to  4  per  cent,  now, 
whereas  3.50  and  under  was  readily  taken  a  short  while 
ago.  The  savings  institutions  are  compelled  to  seek 
more  remunerative  investments.  If  they  would  con- 
tinue to  pay  3 \  or  4  per  cent,  to  depositors  they  cannot 
very  well  invest  in  bonds  yielding  less — for  instance 
government  issues,  yielding  2  per  cent,  and  less, 
savings-bank  depositors  therefore  have  felt  the  effect 
of  a  low  yield.  In  fact,  very  few  such  banks  in  the 
country  pay  as  high  as  4  per  cent.  Those  that  con- 
tinue to  do  so,  do  it  in  large  measure  on  the  strength 
of  investments  made  years  ago  when  good  securities 
were  to  be  purchased  on  a  4,  5,  6,  7,  and  sometimes  8 
per  cent,  basis.  At  the  present  time  the  average  yield 
is  hardly  4  per  cent.,  and  a  little  less  from  the  better 
class  of  securities.  The  old  bonds  purchased  years  ago 
are  rapidly  coming  to  maturity  and  being  refunded  by 
those  of  lower  yield. 

That  investors  should  demand  larger  returns  than 
heretofore  is  not  surprising;  development  of  the  tre- 
mendous resources  of  our  country  affords  ample  oppor- 
tunity for  a  fair  return  upon  capital.  Their  demand  is 
for  a  yield  equivalent  to  the  market  value  of  money 


Interest  107 

and    representing    its     self-relying     earning     power. 

In  no  other  direction  is  this  more  evident  than  in  the 
market  for  municipal  securities.  A  conspicuous  fea- 
ture during  the  year  1905  in  the  sales  of  this  class 
of  bonds  was  the  rise  in  interest  rates.  Less  than 
$6,000,000  at  3  per  cent,  were  put  out  in  the  whole 
country  in  that  year.  In  the  following  year  the  upward 
tendency  was  more  markedly  displayed  than  before,  for, 
as  is  well  known,  New  York  City  was  obliged  to  abandon 
3}  per  cent,  bonds  for  4  per  cents.  A  few  years  ago 
the  city  was  able  to  float  $9,000,000  of  bonds  bearing 
2  J  per  cent:  interest  and  to  sell  them  at  par  and  above. 
Conditions  then  began  to  change.  It  was  compelled 
to  issue  obligations  at  3  per  cent.,  then  at  3  J  per  cent., 
and  recently  has  found  it  no  longer  possible  to  put  them 
out  at  3^  per  cent,  and  the  rate  has  been  advanced  to 
4  per  cent.,  beyond  which  the  charter  limits  will  not 
permit  the  city  to  borrow  money. 

A  comparative  statement  of  figures  is  illuminating 
and  well-nigh  conclusive  in  this  instance.  The  higher 
basis  here  given  is  in  nearly  every  case  the  result  of  an 
increased  interest  rate. 

1900  1906 

Basis  Basis 

Chicago         .          .          .          .3.10  3.80 

St.  Louis       .          .          .          .      3.10  3.35 

Boston          .          .          .          .     3.05  3.50 

•5* 


New  York     .          .          .          .2.98          ^ 

Philadelphia  .          .          .2.90  3.35 

Cleveland      .          .          .          .      3 . 10  3 . 50 

Cincinnati     ....      3.08  3.35 

In  some  measure,  this  condition  of  affairs  may  be 
accounted  for  because  of  the  rapid  industrial  develop- 
ment going  on  which  absorbs  capital  under  too  favor- 


io8  Investment  Bonds 

able  terms  to  investors  to  leave  much   for  investment 
in  low  yield  municipal  and  Government  bonds. 

Our  Government  bonds  are  apparently  a  flat  con- 
tradiction of  the  statement  that  interest  rates  are 
rising  in  greater  or  less  degree,  according  to  the  class 
of  bond.  They  have  consistently  dropped  in  the 
i/  interest  carried  until  the  later  issues  are  practically  at 
the  minimum — 2  per  cent.  Sufficient  has  been  said 
to  show  that  it  is  only  because  of  the  unnatural  con- 
ditions under  which  they  live  that  this  is  possible. 
The  Government  has  so  reduced  its  rate  that  the 
yield  is  now  at  a  point  where  they  cannot  be  bought 
except  by  those  to  whom  income  is  no  object. 

It  is  true,  public  credit  of  the  country  generally  is 
high,  nevertheless,  they  sell  on  a  basis  returning  far 
less  than  the  issues  of  any  other  government.  Figures 
speak  louder  than  words.  At  the  opening  of  the  Civil 
War  national  credit  was  on  a  12  per  cent,  basis 
whereas  now  it  is  less  than  2  per  cent. 

Equally  as  marked  for  their  descent,  although  it 
has  not  been  so  great,  have  been  interest  rates  on 
railroad  issues.  For  many  years  such  bonds  have 
been  available  and  a  profitable  form  of  investment. 
There  was  a  time,  however,  in  their  early  existence 
when  they  sold  with  difficulty,  as  they  had  not  estab- 
lished a  place  in  the  confidence  of  the  public.  In  those 
days  when  the  country  was  young  and  the  railroads . 
primitive,  there  was  little  inducement  to  invest  in  their 
securities  and  so  they  were  compelled  to  borrow  not 
only  under  high  rates  but  even  sell  at  a  discount. 
Many  of  these  old  issues  bore  6,  7,  and  even  8  per  cent. 
From  such  figures  the  rates  have  dropped  until  now 
the  basis  for  the  entire  funded  debt  of  all  the  railways 
'  of  the  United  States  is  approximately  4.25  per  cent. 


Interest  109 

In  1903  statistics  showed  it  to  be  4.47  in  comparison 
with  which  it  is  interesting  to  note,  the  capital  stock 
was  on  a  2.70  basis. 

Advances  in  rate  and  basis  of  railway  bonds  are  now 
slow  and  slight  since  these  securities  already  return  a 
fair  income.  Such  advances  as  occur  from  time  to  time 
are  largely  confined  to  special  types  and  cannot  be  said 
to  be  general. 

With  industrial  corporations,  prevailing  rates  are 
higher  than  railways  and  much  above  Government 
and  municipal  figures;  investors  exact  a  high  return. 
The  great  majority  of  recognized  bonds  of  this  class 
bear  5  and  6  per  cent.,  and  since  many  of  them  sell  below 
par  the  yield  is  very  high. 


CHAPTER  X. 

SECURITY. 

IT  has  been  said  for  investments  that  there  is  no 
such  thing  as  absolute  safety  and  from  experience 
many  are  ready  to  concur.  Theoretically,  it  cannot 
be  denied;  practically  it  is  an  extreme  statement  the 
refutation  of  which  is  a  goodly  number  of  investments, 
especially  bonds,  that  have  stood  the  test  of  time  until 
now  and  undoubtedly  will  for  many  years  in  the 
future. 

For  a  few  lenders  willing  to  take  some  risk,  there  are 
thousands,  cautious  and  conservative,  who  wish  to  be 
certain  of  their  return.  Besides  institutional  investors, 
whose  attitude  in  this  regard  is  well  known,  there  are 
thousands,  without  aptitude  or  inclination  for  busi- 
ness, who  must  put  their  money  into  securities  that 
will  give  absolutely  no  anxiety  nor  concern  until 
maturity. 

The  acme  of  investment  excellence  is  a  bond 
combining  three  qualities;  safety,  profitableness,  and 
permanency.  Absolute  safety,  assured  profit  and  un-r 
changeable  conditions  ordinarily  are  relatives.  There 
are  investments  more  safe  than  profitable ;  others  pro- 
fitable but  lacking  safety ;  and  it  is  not  difficult  to  find 
many  neither  safe  nor  profitable  but  decidedly  per- 
manent. Any  one  of  these  three  qualties  may  appeal 
most  strongly  to  an  investor  but  this  again  depends 
on  other  conditions.  Concededly,  the  great  majority 

no 


Security  m 

of  investors  buy  with  an  eye  single  to  the  first ;  they  are 
unanimous  in  their  demand  for  safety,  making  it  the  v 
foundation  virtue.  Pressed  for  an  enumeration,  how- 
ever, of  its  elements  in  various  bond  issues  or  for  an 
analysis  of  the  position  of  a  bond  they  would  be  at  a 
loss. 

Happily,  the  ability  and  integrity  of  the  banker 
safeguards  them  and  his  word  has  come  to  be  largely 
as  good  as  his  bond.  His  recommendation  is  based 
on  his  knowledge ;  his  knowledge  of  a  bond  is  analytic ; 
his  training  and  business  organization  enable  him  to 
measure  the  security  of  a  bond  with  accuracy. 

In  consideration  of  security  two  things  are  kept  in 
mind;  the  degree  of  certainty  with  which  one  may 
expect  to  receive  back  his  invested  capital — the  security 
of  principal;  and,  the  degree  of  certainty  with  which 
he  may  expect  to  receive  the  increment  from  his  in-  • 
vested  capital,  at  the  time  and  in  the  amounts  stipu- 
lated in  the  contract — the  security  of  interest.  One, 
the  first  mentioned,  is  much  the  concern  of  a  distant 
future;  the  other  is  a  matter  of  the  next  moment,  so 
to  speak,  for  interest  begins  immediately  and  its  first 
payment  is  not  more  than  six  months  away. 

Ordinarily  each  is  considered  on  its  own  merits  but 
final  analysis  reveals  a  close  relationship  and  shows 
the  security  of  principal  to  be  greatly  dependent  on 
the  safety  and  punctuality  of  interest.  In  fact,  favor- 
able consideration  of  a  bond  from  the  interest  stand- 
point almost  invariably  involves  similar  judgment  as 
to  the  safety  of  principal.  If,  for  the  full  period  of 
years,  and  with  unfailing  regularity  one  shall  receive 
interest  on  his  investments,  it  follows,  most  naturally, 
that  finally  his  principal  will  be  returned.  Or,  con- 
versely, if  continued  default  be  made  of  interest,  how 


Investment  Bonds 

can  bondholders  expect  to  realize  their  full  principal 
from  a  weak  and  enfeebled  corporation  ? 

From  time  immemorial  men  have  been  compelled 
to  pledge  their  property  that  creditors  might  not  suffer 
should  they  default  on  their  obligations.  Even  so  is 
it  with  most  corporations  in  the  greater  part  of  their 
borrowings  through  the  instrumentality  of  bond  issue. 
Aside  from  those  of  public  corporations,  most  bonds 
are  secured  by  a  lien  on  property  which  lien  is  evi- 
denced by  a  mortgage.  In  the  very  nature  of  things 
it  is  impossible  for  a  public  corporation  to  give  tangible 
security  in  the  form  of  pledge  of  property. 

The  intrinsic  value  of  property  named  in  a  mortgage 
may  be  used  as  a  basis  on  which  to  establish  a  reason- 
ably sound  conclusion  as  to  the  security  of  the  bond 
and  is  generally  so  treated  by  the  practical  financier 
and  investor.  Though  this  value  is  a  great  element 
of  strength  it  cannot  be  absolutely  the  basis  of  con- 
fidence. Were  the  value  of  pledged  property  the  only 
safe  basis  for  judgment,  unsecured  bonds  would  be  an 
impossibility  and  it  is  but  necessary  to  read  the  lists 
to  know  that  some  very  meritorious  issues  are  in  the 
market  back  of  which  there  is  nothing  save  the  in- 
tegrity and  position  of  the  obligor. 

Seemingly  the  first  mortgage  bond  and  the  debenture 
are  extremes  of  safety;  yet  in  a  final  analysis  their 
respective  values  are  measured  by  much  the  same 
standards.  If  safety  and  security  of  a  bond  be  in  pro- 
portion to  the  strength  of  a  lien  on  the  property  of  a 
corporation,  what  is  the  position  of  various  classes  of 
bonds?  Consider  first  government  issues;  what  shall 
be  their  claim  to  recognition  as  securities  of  permanent 
worth?  Giving  no  lien,  generally,  of  any  kind  to 
secure  interest  payments,  and  never  any  to  insure  re- 


Security  113 

payment  of  principal,  judged  by  this  standard,  they 
would  naturally  fall  far  short  of  ideally  safe  investments 
which,  in  many  cases,  is  quite  opposite  from  the  facts 
and  especially  with  United  States  bonds. 

Likewise,  many  municipal  bonds  are  not  certain  of 
ultimate  redemption  nor  is  their  interest  secured  by  any 
property  lien.  But  in  the  field  of  private  and  semi- 
public  enterprise,  we  find  a  highly  developed  system 
of  security  by  lien  on  property. 

Industrial  corporations  are  slowly  putting  mortgages 
upon  themselves;  public  utilities  companies  are  more 
or  less  covered  by  such  liens  while  the  railways  are 
buried  on  some  sections  five,  six,  and  seven  deep — a 
swarm  of  liens,  First,  Second,  Third,  Consolidated, 
General,  Unified  and  what  not — all  are  catalogued 
among  the  obligations  of  these  corporations.  The 
combination  of  mortgage  security  with  other  favorable 
circumstances  has  brought  a  large  part  of  railroad 
issues  to  a  position  in  which  their  security  is  regarded 
second  only  to  that  of  our  Government  bonds. 

Property  underlying  the  great  masses  of  secured 
bonds  is  of  all  kinds  and  classifications.  Most  of  this 
physical,  or  apparent,  security  is  real  property.  The 
railroads  give  their  lands,  roadbed,  stations,  terminals ; 
industrial  corporations,  so  far  as  the  practice  extends, 
pledge  their  plant  and  other  real  property  and  the 
public  utility  corporations  do  likewise.  But  this  has 
not  been  enough:  the  last  few  years  have  been  pro- 
ductive of  great  issues,  underlying  which  is  personal 
property.  In  the  development  of  corporate  life  and  the 
acquisition  of  subsidiary  properties,  great  quantities  of 
securities  have  been  acquired  by  many  corporations. 
These  have  been  used  as  a  basis  for  bonds,  chiefly  of  the 
collateral  trust  type,  which  has  proved  so  successful 


n4  Investment  Bonds 

in  the  market  at  large.  Not  alone  securities,  but 
other  forms  of  personal  property  are  used;  cars  and 
equipment  of  railroads,  for  instance.  Frequently  a 
mortgage  is  so  comprehensive  in  its  terms  that  it 
covers  all  property,  real  and  personal,  and  further 
adds  to  the  apparent  security  by  including  all  addi- 
tional acquirements  with  the  proceeds  of  the  bonds  or 
otherwise.  A  quotation  from  such  a  document  will 
serve  to  illustrate — "The  bonds  are  secured  by  a  mort- 
gage on  the  franchises,  railroads,  equipment,  leases, 
real  estate,  and  other  property  now  owned  and  here- 
after acquired/*  Without  an  "after  acquired'*  prop- 
erty clause,  more  than  one  issue  would  have  been 
unsuccessful.  By  agreement  or  special  permission 
from  bondholders,  a  company  may  obtain  the  right  of 
substitution  of  property  under  its  mortgage,  placing 
equally  valuable  property  under  the  lien. 

It  might  be  said,  therefore,  and  with  some  show  of 
reason,  that  the  feature  of  a  bond,  as  a  financial  instru- 
ment, is  its  strength  and  ability  to  compel  its  own  pay- 
ment by  satisfaction  of  its  lien  upon  property.  But  it  is 
an  illusion  to  believe  that  this  can  be  easily  accomplished. 
Formalities  without  number,  the  long  and  tedious  pro- 
cess of  the  law,  commercial  considerations  and  ques- 
tions of  polity  and  equity  are  so  interwoven  that  it  is 
next  to  impossible,  in  most  cases,  to  take  the  property 
for  satisfaction  of  one's  debt. 

If  these  things  be  so,  wherein  lies  the  chief  element 
of  safety  and  security  of  an  investor  who  pins  his  faith 
on  the  written  word?  Surely,  security  is  of  utmost 
importance  in  the  consideration  of  a  bond.  Answer 
may  be  made  that,  generally  speaking,  a  bond  is  a  prior 
claim  on  both  assets  and  income.  The  language  of 
a  mortgage  lends  itself  to  an  interpretation  making 


Security  115 

supreme  the  lien  upon  assets,  but  commercially  speak- 
ing the  mortgage  is  really  upon  the  company's  revenues. 

Creditors  of  a  company  are  most  dependent  for  se- 
curity, not  upon  the  property,  as  such,  but  upon  the 
business  for  which  the  company  was  organized.  The 
whole  property  of  a  railroad  considered  as  real  estate 
and  old  material  is  worth  but  a  fraction  of  the  amount 
for  which  it  is  mortgaged  and  worth  nothing  to  any  one 
except  engaged  in  the  same  business.  Keeping  in  mind 
the  double  consideration  of  security  of  interest  and 
principal,  and  that  the  conditions  which  make  interest 
secure  are  really  the  actual  security  for  principal,  the 
conclusion  is,  that  if  the  business  is  safe  the  bonds  are 
safe;  if  the  business  is  profitable,  the  bonds  are  safe. 

For  government  and  municipal  issues  there  is  no 
gauge  of  profit-making  ability.  Their  security  lies  es- 
sentially in  the  ability  and  willingness  of  the  people  to 
be  taxed  and  the  resources  which  may  be  drawn  upon. 
Some  government  issues,  such  as  one  or  two  Japanese 
loans,  are  protected  by  a  first  claim  on  a  specific  revenue 
such  as  customs  duties  or  internal  revenue  on  tobacco, 
but  they  are  few.  The  security  of  government  bonds 
is  at  once  political,  economic,  and  financial  considera- 
tions and  is  a  question  broad  in  scope.  In  a  country 
like  the  United  States,  where  the  resources  of  the 
people  are  large,  where  taxation  has  not  become  unduly 
burdensome  except  in  special  cases,  and  where  a  high 
standard  of  public  obligation  exists,  government 
securities  have  the  advantage  of  being  of  unquestioned 
value. 

The  important  elements  of  security  in  municipal 
bonds  are  several.  Though  broad  in  scope,  they  are 
more  defined  than  with  government  bonds.  They  may 
be  studied  at  closer  range  and  their  position  reduced  to 


n6  Investment  Bonds 

a  point  where  nearly  perfect  judgment  is  possible.  As 
has  been  shown,  generally  no  lien  safeguards  the  in- 
vestor, yet  ultimately  the  burden  of  security  is  shifted 
upon  property  valuation.  It  is  the  assessed  valuation 
which  yields  the  tax  to  pay  the  bond.  It  is  the  ratio 
of  the  debt  to  real  assessment  which  must  enter  into 
calculations.  Add  to  these  the  problematical  moral 
hazard  and  the  technical  questions  of  legality,  together 
with  retrospect,  aspect,  and  prospect  of  the  town,  city, 
or  county,  in  conduct,  management,  and  development 
and  the  ground  is  covered.  So  searching  an  investiga- 
tion is  no  small  labor  but  only  as  it  develops  these  points 
is  the  safety  of  a  municipal  issue  known. 

Safety  of  industrial  bonds  involves  no  fewer  considera- 
tions although  these  are  somewhat  different  in  charac- 
ter. Emerging  from  the  preliminary  tests  of  value, 
many  of  them  are  on  the  high  road  to  the  position  of 
stable  investment  securities.  They  have,  very  largely, 
passed  through  the  period  of  experiment  and  stress 
but  for  patent  reasons  have  not  attained  the  position 
of  government  or  railway  obligations.  Fundamentally, 
the  security  of  this  class  of  bonds  lies  in  stability  and 
progress  in  business  conditions.  The  obligations  of  a 
strong  government  are  far  less  subject  to  the  influence  of 
prosperity  and  adversity  than  those  of  manufacturing 
corporations.  Earnings  of  these  concerns  reflect  im- 
proving general  conditions  much  more  promptly  than 
do  the  earnings  of  railroads.  It  is  also  true  that  when 
the  tide  of  business  turns,  their  earnings  decline  much 
more  abruptly  than  any  others. 

Changing  business  conditions,  therefore,  mean 
instability  of  demand  for  their  products  or  services 
and  this,  naturally,  means  instability  in  profits.  Un- 
less substantial  surplusses  are  built  up,  a  weakened 


Security  117 

foundation  for  their  bonds  is  inevitable.  Happily, 
the  prosperity  of  the  times  has  enabled  many  to  do 
this  and  their  funded  obligations  are  becoming  more 
and  more  established  in  the  confidence  of  investors. 

Notwithstanding  a  waxing  prosperity,  elements  of 
insecurity  are  always  present.  Chief  among  these  is 
the  danger  of  competition.  The  very  success  of  an 
enterprise  may  induce  others  to  enter  the  field. 

The  day  of  genuine  competition  between  railway 
lines  by  paralleling  or  between  common  points  is 
practically  past.  Competitive  forces  have  been  largely 
eliminated  from  the  transportation  problem  as  more 
than  sixty  per  cent,  of  the  railways  are  so  closely  united 
as  to  amount  to  a  practical  community  of  interest. 
The  era  of  struggle  for  supremacy  among  manufac- 
turing corporations  however,  is  yet  here,  though  fast 
fading  away  because  of  the  growing  tendency  toward 
consolidation  into  trusts. 

Other  dangers  lurk  about  these  purveyors.  There  is 
always  the  possibility  of  fresh  or  increased  burdens  of 
taxation;  always  the  spectre  of  adverse  legislation  on 
questions  of  tariff  both  at  home  and  abroad.  Still 
again  the  basis  of  a  business  may  be  its  ownership  of 
patents  which  must  sooner  or  later  expire  when  others 
may  enter  the  field.  Shipping  facilities,  contracts,  and 
character  of  management  must  all  be  considered.  In 
this  latter  there  must  be  constructive  ability,  origin- 
ality, and  aggressiveness.  The  affairs  of  large  indus- 
trial combinations  must  not  be  at  a  disadvantage  with 
competitors. 

Bonds  of  public  utility  corporations,  those  corpora- 
tions that  control  the  street-car  lines,  water-works 
systems,  telegraph  and  telephone  systems,  light,  heat, 
and  power  plants,  are  largely  secured  by  an  element 


n8  Investment  Bonds 

not  found  elsewhere,  and  that  is  the  franchise.  In  a 
broad  sense,  the  steam  railways  are  franchise  corpora- 
tions but  the  franchise  is  not  their  most  prominent 
asset.  This  right  to  serve  the  people,  whether  it  be 
in  transportation  through  the  streets  or  supplying 
other  needs,  very  essentially  affects  the  value  and 
stability  of  public  utility  securities.  As  an  asset,  the 
security  of  their  bonds  is  founded  more  on  this  than  in 
the  value  of  plants  and  other  property. 

Along  with  the  usual  business  considerations  which 
are  well-nigh  classic  in  the  judgment  of  industrial  and 
railroad  bonds,  is  this  especially  important  matter  of 
franchise.  Its  length  for  one  thing;  in  case  of  street 
railways  the  exclusive  privilege  to  operate  is  sometimes 
limited  to  a  term  of  years.  Its  scope — that  is,  the 
ability  to  expand  and  freedom  from  limitations;  and 
the  likelihood  of  renewal.  These,  with  the  extent  to 
which  the  services  or  products  are  necessities,  give  to 
this  privilege  its  value  and  determine  the  safety  and 
security  of  the  obligations  built  upon  it. 

Most  difficult,  because  most  complex,  is  the  deter- 
mination of  security  back  of  railroad  bonds.  They 
are  generally  backed  up,  to  be  sure,  by  mortgage  liens 
on  very  valuable  property,  (for  its  purposes)  but  the 
execution  of  such  documents  by  such  strong  and  homo- 
geneous systems  as  the  Pennsylvania  Railroad  or  New 
York  Central  is  little  more  than  formality.  Ably 
financed  and  ever  increasing  in  strength,  default  on 
any  of  their  obligations  seems  but  a  remote  possibility. 

One  of  the  greatest  factors  in  the  strength  of  our 
railroads  is  the  growing  tendency,  indeed,  the  avowed 
policy,  of  unification  and  consolidation.  Great  sys- 
tems are  being  welded  from  branch  lines,  divisions, 
subsidiary  and  terminal  companies;  all  are  being 


Security  119 

brought  together  in  one  harmonious  whole.  The 
prediction  is  even  ventured  by  some  that  consolidation 
may  sometime  unite  the  entire  railway  systems  of  the 
United  States  under  one  general  management. 

Obviously  this  solidarity  and  greatness  makes  for 
fixedness  of  policy  and  consequent  stability  and  safety 
of  their  securities. 

Unquestionably,  the  railways  have  the  greatest 
diversity  in  their  securities.  Practically,  they  resolve 
into  those  protected  by  a  mortgage  on  the  general 
property,  those  secured  by  a  lien  on  rolling  stock,  and 
those  underlaid  by  other  securities.  While  these  are 
the  forms  of  security  and  clearly  distinguished,  the 
substance,  to  a  great  extent  is  in  other  things.  No 
well-informed  investor  ever  buys  such  bonds  really 
expecting  the  property  to  be  sold  to  satisfy  his  claim. 
His  action  does  not  hinge  upon  the  question  whether 
the  value  of  the  property  is  sufficiently  in  excess  of 
the  amount  of  the  mortgage,  but  rather,  as  with  in- 
dustrials, upon  the  earning  capacity  and  future  growth 
of  the  company. 

That  permanent  earning  power  chiefly  makes  value 
may  be  illustrated  by  comparison  of  the  security  of 
bonds  of  two  lines,  equal  in  cost  of  construction,  length, 
and  efficiency  of  operation,  but  one  in  South  America, 
the  other,  say,  in  Connecticut  or  New  York.  Immedi- 
ately is  it  manifest  that  earnings  are  the  cornerstone 
of  security. 

Therefore,  if  the  matter  of  earnings  is  so  great  a 
factor  in  the  problem,  it  follows  that  the  general 
credit  and  financial  strength  of  a  company  are  of 
paramount  importance  in  the  consideration  of  security ; 
and  the  better  they  are  the  firmer  it  is. 

An  analysis  of  the  position  of  a  railroad  must  place 


i2o  Investment  Bonds 

every  vital  element  in  a  clear  light  and  in  its  proper 
relation  to  all  others.  It  must,  with  all  thoroughness, 
dissect  the  questions,  physical,  commercial,  financial, 
and  personal,  for  out  of  the  harmony  of  these  come 
large  earnings  and  good  profits. 

The  geographical  position  of  a  road  may  be  its  salva- 
tion or  its  greatest  handicap.  Not  alone  should  it 
serve  a  territory  that  is  developing,  through  an  influx 
of  population  and  consequent  establishment  of  new 
towns  and  expansion  of  old  ones,  but  it  should  be 
favorably  located  with  respect  to  its  connections. 
Contrast  the  position  of  a  small  line  forming  essentially 
a  connecting  link  between  two  greater  systems,  and 
that  of  a  small  branch  line,  a  ward,  as  it  were,  of  the 
greater  company.  The  bonds  of  one  are  secure  upon 
their  own  foundation ;  the  others  may  be  almost  entirely 
dependent  upon  the  care  of  the  larger  company.  Very 
often  the  policy  of  a  company  is  largely  dictated  by  its 
position .  I f  its  contiguous  territory  is  served  by  another 
line,  there  is,  in  a  measure,  competition.  If  pressed  by 
parallel  lines  or  in  danger  of  this  in  the  future,  it  must 
adapt  itself  accordingly;  if  earnings  depend  much  on 
business  from  connections,  relations  with  them  must 
be  strengthened. 

Position  is  vital  in  determining  the  character  of 
traffic.  There  are  the  "Grangers,'*  the  grain-carrying 
roads  of  the  West;  the  "Coalers,"  the  coal -carriers  of 
the  East,  and  others,  the  bulk  of  whose  freight  is  lumber. 
Experience  has  shown  that  diversified  traffic  gives 
greatest  stability  of  earnings.  With  but  one  or  two 
classes  of  traffic  in  the  main,  a  road  might  suffer 
greatly  should  a  business  depression  affect  the  market 
for  those  particular  commodities.  A  bad  failure  of 
crops  might  jeopardize  interest  payments;  the  ex- 


Security  121 

haustion  of  natural  products  could  leave  a  road  almost 
valueless.  In  fact,  from  time  to  time,  short  lines  in 
forest  country  are  fully  abandoned  for  this  reason. 

Complementary  to  the  question  of  traffic  is  operating 
efficiency.  Maximum  load  and  minimum  cost  are 
watchwords  of  every  operating  official;  and,  indeed, 
must  be,  for  herein  is  the  test  of  his  ability.  More- 
over, operating  efficiency  is  the  pivotal  point  on  which 
swing  earnings.  In  a  careful  analysis  of  this  item  in 
the  annual  report,  the  first  consideration  is  its  ratio  to 
gross  earnings.  Important  as  this  is,  it  cannot  be 
regarded  absolutely  as  the  criterion  of  efficiency. 
Considerable  variation  exists  in  the  reports  of  roads, 
due  to  difference  in  methods,  and  a  less  ratio  in  one 
does  not  necessarily  indicate  greater  economy.  As- 
suming, however,  proper  maintenance  and  improve- 
ment of  the  property  throughout,  the  lesser  ratio 
generally  means  greater  net  earnings. 

Efficiency  in  operation  of  trains  and  handling  of 
business,  of  course  presupposes  full  co-operation  of  the 
entire  management.  In  the  present  day,  policies  of 
management  are  fairly  well  fixed,  especially  of  the 
larger  roads,  nevertheless,  the  investor  is  bound  to 
inquire  into  these  for  the  reputation  of  a  management 
for  conservatism  or  otherwise. 

We  have  seen  that  the  focus  of  all  operations  is  net 
earnings  (as  derived  from  best  practice) ;  yet  gross 
earnings  require  careful  consideration.  The  propor- 
tion of  net  to  gross  from  year  to  year  is  significant. 
Dwindling  or  small  gross  receipts,  notwithstanding 
well  proportioned  net,  might  indicate  that  the  business 
is  unsatisfactory.  Analyzing  these  figures,  the  income, N 
net  and  gross  per  mile,  is  derived;  and  this  may  be 
compared  with  capitalization  figures  on  the  same  basis. 


122  Investment  Bonds 

Considerable  importance  attaches  to  this  question. 
The  proportion  of  stock  to  bonded  debt  should  be 
within  reason,  and  the  capitalization,  per  mile,  in 
general,  and  by  bonds  of  the  issue  under  consideration, 
together  with  prior  liens,  should  bear  a  proper  relation 
to  the  earning  capacity  per  mile. 

Any  critical  examination  of  the  security  back  of  a 
bond  is  certain  to  lay  stress  upon  the  item  of  fixed 
charges,  which  include  usually,  taxes,  interest  on  funded 
and  floating  debt,  and  sinking  funds.  By  reduction  of 
these  charges  to  the  per  mile  basis  comparisons  may  be 
readily  made.  Viewed  in  relation  to  net  earnings,  the 
most  concise  advice  possible  comes  from  a  man  of  wide 
financial  experience,  who  said : ' '  Never  invest  in  the 
bonds  of  an  enterprise  until  it  can  show  actual  net 
earnings  of  not  less  than  twice  the  amount  required 
to  pay  interest  on  its  bonds."  Whether  such  is  a 
dictum  for  every  case  is  an  open  question.  Certain 
it  is,  there  should  be  sufficient  margin  to  insure  pay- 
ment if  temporary  failure  of  income  should  come  about. 

In  the  experience  of  some  corporations  declining 
business,  overburdening  debt,  or  incompetent  manage- 
ment are  forerunners  of  reorganization,  a  time  of 
crucial  test  of  the  security  of  each  bond  issue.  Fore- 
closure, be  it  reiterated,  is  generally  impracticable, 
hence  in  reorganization  the  bonds  suffer  in  proportion 
to  their  relative  position  among  all  obligations. 

If  it  is  a  railroad,  where  terminals,  branch  lines,  and 
subsidiary  companies  are  covered  by  their  own  mort- 
gages, and  over  all  are  spread  general  mortgages,  senior- 
ity of  lien  and  the  relative  value  of  the  component  part 
to  the  future  success  of  the  whole  will  avail  for  much. 
So  therefore,  in  anticipation  of  such  a  contingency 
as  liquidation,  the  relative  position  of  different  issues 


Security  123 

should  be  clearly  established  by  an  investor.  How 
near  to  the  road  the  security  is  and  how  much  indebted- 
ness precedes  are  vital  points.  First  mortgage  does 
not  always  mean  first  lien;  a  consolidation  of  several 
properties  may  be  put  under  this  general  mortgage 
which  would  be  the  first  lien  on  the  railroad  company, 
in  toto,  but  not  a  first  lien  on  its  constituent  properties. 

Then  there  are  first  and  consolidated  mortgages, 
very  often  a  real  first  lien  on  only  a  small  portion  but 
consolidated  for  the  greater  part  and  subject  to  prior 
liens.  If,  however,  retirement  of  prior  liens  has 
progressed  well,  these  general  mortgages,  under  a 
readjustment  of  affairs,  may  fare  well,  since  through 
the  maturing  of  prior  liens  they  often  become  a  full- 
fledged  first  lien. 

Generally  speaking,  two  methods  of  determining 
the  safety  and  security  of  a  bond  present  themselves- 
One  is  internal  examination,  that  is,  careful  scrutiny 
of  figures,  statistics  and  other  corporation  facts;  the  * 
other,  somewhat  less  exact,  is  a  proper  observation  of 
outward  manifestations  of  corporate  vigor.  More 
or  less  pronounced  with  the  type  of  bond,  they  are 
indubitable  earmarks  of  soundness  or  instability. 
Most  significant,  perhaps,  is  interest  rate;  with  some 
slight  exceptions,  safety  and  security  vary  inversely 
with  the  rate  of  interest.  The  nearest  approach  to 
absolute  safety  is  United  States  Government  bonds; 
their  interest  rate,  also,  be  it  noted,  is  the  minimum 
that  could  be  offered  on  any  security.  Compensation 
for  risk  is  generally  in  larger  return,  hence  it  is  an  almost 
universally  established  principle  governing  investments 
that  beyond  a  proper  average  for  each  class  of  bonds, 
which  might  be  considered  as  a  standard,  the  risk 
increases  with  the  rate  of  interest. 


124  Investment  Bonds 

Or,  if  a  different  yet  related  index  be  taken,  it  could 
be  the  premium  at  which  they  stand;  security  and 
solvency  determine  this  to  a  great  extent.  Competition 
for  the  best  will  soon  lift  their  price,  which,  in  the  long 
run,  is  an  earnest  of  safety.  In  a  general  decline  of 
prices,  the  depreciation  of  different  kinds  of  bonds  is 
not  uniform;  the  higher  the  class  and  the  more  secure 
they  are,  the  less  pronounced  is  the  depreciation.  Some 
lower  forms  of  obligation  are  likely  to  fall  compar- 
atively much. 

There  are  yet  other  indications  to  guide  an  investor. 
Good  bonds  have  a  good  market  which  is  generally 
a  broad  market.  It  cannot  be  laid  down  as  an  infalli- 
ble rule,  but  such  as  enjoy  a  broad  market  reflect  a 
favorable  judgment  in  which  the  element  of  security 
is  a  great  part. 

Best  of  all  is  the  finger  post  of  the  law  governing  our 
savings  banks;  tried  and  not  found  wanting,  it  points 
out  investments  by  name,  class,  or  qualification  that 
may  be  accepted  without  question.  In  its  solicitude 
for  the  welfare  of  these  institutions,  distinction  runs  to 
discrimination,  and  if  it  errs,  it  is  far  over  on  the  safe 
side.  Bonds  that  measure  up  to  its  requirements  are 
good,  par  excellence,  and  the  individual  who  accepts 
and  follows  its  gratuitous  advice  will  seldom  have 
cause  for  regret. 


CHAPTER  XI. 

GUARANTEE. 

BACK  of  hundreds  of  issues,  of  all  sizes  and  descrip- 
tions, many  of  which  are  not  to  be  found  in  the  open 
market,  while  others  are  spread  broadcast,  is  this 
liability  of  guarantee,  a  transaction  arising  out  of  the 
varied  circumstances  under  which  these  bonds  are 
issued  or  come.  Sometimes  the  guarantee  of  an  issue 
is  a  question  of  policy,  at  other  times  an  urgent 
necessity. 

Considerations  of  this  character  essentially  deter- 
mine the  scope  of  the  guarantee.  No  more  than  the 
responsibility  for  the  payment  of  principal  at  maturity 
may  be  required,  which  is  a  burden  of  doubtful  weight 
on  the  guarantor,  especially  if  the  term  be  long;  or, 
what  might  prove  to  be  a  little  onerous  to  the  guarantor, 
would  be  to  become  answerable  for  the  interest  pay- 
ments only.  If  exigencies  of  the  moment,  however, 
demand  a  stronger  pledge,  then  both  the  principal  and 
interest  are  safeguarded  in  this  way. 

In  a  majority  of  cases,  it  is  the  entire  issue  that  is 
covered  by  the  guarantee.  The  exceptions  are  partial 
guarantees  where  only  a  portion  of  the  issue,  often  the 
larger,  comes  under  its  sheltering  wing.  Guarantees 
often  grow  out  of  reorganization  proceedings,  when 
bond-holders  may  be  reluctant  to  approve  arrangements 
whereby  apparently  more  is  lost  than  by  exercise  of 
their  rights.  In  compensation,  therefore,  for  assent  to 


i26  Investment  Bonds 

some  loss  by  reduction  of  interest  for  the  future,  this 
assurance  is  given  on  which  they  may  build  a  reason- 
able hope  that  from  that  time  on  the  bonds  are  at  least 
safe. 

As  applied  to  principal,  a  guarantee,  is,  of  course, 
only  operative  at  the  end  of  a  long  period.  Not  so 
with  interest.  Here  it  runs  along  with  time  and  at 
any  moment  the  guarantor  may  be  called  upon  to  pay 
this  charge.  But  the  life  of  a  guarantee  is  not  always 
that  of  the  bonds  themselves.  Frequently  an  issue 
is  protected  only  for  a  specific  period  which  is  shorter 
than  the  run  of  the  bond.  Because  of  serious  doubts 
of  investors  of  the  ability  of  a  property  to  earn  its 
interest  charges  at  the  outset,  the  guarantor,  of  what- 
ever identity,  must  give  its  word  that  these  will  be  paid, 
notwithstanding.  Such  an  arrangement  is  usually 
for  five  or  ten  years.  A  continuing  obligation  would 
often  be  unnecessary  since  in  so  generous  a  probationary 
period  the  property  may  full  well  demonstrate  a 
capacity  to  care  for  itself. 

Development  of  railways  into  great  systems  and  the 
growth  of  other  forms  of  corporate  enterprise  into  vast 
consolidations  means  that  vast  quantities  of  securities 
of  their  constitutent  parts  must  be  cared  for  in  some 
manner.  Sometimes  a  whole  issue  is  cancelled  and  a 
new  one  of  the  controlling  company  substituted.  Many 
other  ways  have  been  devised  for  accomplishing  this, 
among  which  is  the  method  of  assuming  the  obligations. 
A  common  error  is  to  confuse  the  identity  of  such 
assumed  bonds  with  those  guaranteed.  Though  they 
may  be  considered  as  close  relations,  distinctive  fea- 
tures sharply  differentiate  them. 

An  assumed  bond,  as  the  term  clearly  implies,  is  an 
obligation  taken  up  by  another  corporation ;  it  becomes 


Guarantee  127 

the  direct  liability  of  that  corporation ;  it  takes  its  place 
in  chronological  order  among  the  liabilities;  it  becomes 
part  and  parcel,  unequivocally,  of  that  corporation's  own 
indebtedness  and  is  so  shown  in  any  full  report  of  debt. 
The  guaranteed  bond,  on  the  other  hand,  is  but  a 
contingent  liability,  second  to  all  other  obligations  of 
the  guarantor  and  taking  no  priority  over  its  subsequent 
issues.  A  company  may,  therefore,  give  its  guarantee 
for  bonds  of  another,  and  later  issue  many  of  its  own, 
all  of  which  would  rank  superior. 

Were  these  fundamental  facts  fully  understood, 
another  popular  misconception  would  not  exist. 
Strangely,  but  truly,  there  are  those  by  whom  certifica-  / 
tion  of  a  bond  is  believed  to  be  guarantee.  No  greater 
variance  from  the  facts  can  be  imagined.  In  no  sense, 
is  certification  such  a  function.  Considering  the  fact 
that  this  is  usually  done  by  the  trustee  of  an  issue,  and 
is  intended  only  as  a  safeguard  against  excessive  issue, 
it  becomes  plainly  evident  that  guarantee  is  quite 
without  the  province  of  a  trust  company  in  that  ca- 
pacity and  the  company  does  not,  of  course,  intend  to 
appear  in  any  way  as  guaranteeing  bonds  which  it  has 
certified. 

In  the  field  of  railroads,  wherein  is  the  most  pro- 
nounced tendency  toward  consolidation  and  where, 
perhaps,  the  most  rapid  growth  is  manifested,  are  the 
greater  number  of  guaranteed  bonds.  Hundreds  of 
little  independent  lines  are  taken  in,  one  by  one,  under 
lease  or  by  purchase,  and  many  branches  are  added  by 
construction. 

When  a  railroad  extends  its  lines,  running  them  into 
different  states,  it  is  always  necessary  that  a  charter  be 
obtained  from  those  states.  Obviously,  such  branches, 
or  separate  companies  as  they  may  be  incorporated, 


128  Investment  Bonds 

are  untried  and  prospects  is  the  only  basis  for  claim  to 
recognition.  With  this  only,  were  they  to  depend 
on  their  own  credit  to  bring  them  funds  for  construc- 
tion, their  securities  would  command  a  low  price  or 
likely  be  unmarketable. 

Now  the  large  company,  in  whose  interest  these 
branches  are  built,  with  its  strong  credit  and  assured 
financial  position,  could  undoubtedly  construct  them 
without  resorting  to  security  issues  at  all.  But  what 
is  often  done  is  to  issue  bonds,  give  a  mortgage  lien  on 
the  new  work,  as  security,  and  place  beneath  it  all  a 
guarantee.  Reinforced  by  the  credit  of  the  larger  com- 
pany, such  bonds  may  be  favored  with  a  good  market. 
Without  it,  a  prospective  purchaser  would  be  in  an  un- 
enviable position  for  what  assurance  has  he  that  these 
companies  or  branches  can  earn  even  the  interest  on 
their  bonds?  The  fact  that  a  large  proportion  do  not, 
lends  emphasis  to  the  necessity  for  this  action. 

The  necessities  of  a  large  line  may  induce  it  to  enter 
into  guarantee  of  another's  bonds.  Such  a  case  is 
found  in  the  Atchison,  Topeka  &  Santa  Fe  System 
where  to  secure  a  connection,  the  Atlantic  &  Pacific 
Railway,  which  is  between  two  larger  portions  of  its 
lines,  it  was  necessary  to  guarantee  that  company's 
bonds.  Because  of  unfortunate  traffic  conditions  and 
arrangements,  insolvency  had  resulted,  endangering 
not  alone  the  line  itself,  but  its  value  to  the  other  as 
a  bridge. 

Sometimes  a  company  that  has  guaranteed  another's 
bonds,  is,  itself,  merged  into  a  larger.  Under  these 
conditions,  a  sub-guarantee  might  be  given  which 
would  be  essentially  assumption  of  the  existing  obliga- 
tion by  the  leasing  or  controlling  company.  This 
would  not  release  the  original  guarantor  but  would 


Guarantee  129 

operate  to  throw  any  burden  eventually  upon  the 
last-named  company. 

A  community  of  interest  in  certain  privileges  is  often 
the  foundation  for  guarantee;  two,  three,  or  more 
railroads  may  enter  a  station ;  several  companies  may 
cross  a  bridge,  or  they  may  enjoy  equal  use  of  a  tunnel. 
There  might  then  be  given  a  joint  guarantee  of  the 
bonds  of  each  of  these  pieces  of  property  and  if  the 
responsibility  were  to  be  more  securely  placed,  the 
obligation  would  be  made  joint  and  several. 

Though  relatively  few,  government  guarantees  are 
given,  more  in  foreign  countries  than  elsewhere,  and 
then,  generally  to  strengthen  the  bonds  of  some  rail- 
road. In  Canada  are  several  instances;  Manitoba 
Province  guarantees  principal  and  interest  on  one  or 
two  branches  of  the  Canadian  Pacific  Railway,  and  the 
same  company,  some  years  ago,  for  relinquishing 
exclusive  right  to  operate  lines  in  Manitoba  to  the  in- 
ternational boundary,  received  the  Dominion  Govern- 
ment guarantee  of  interest  on  a  large  issue  of  land 
bonds.  Yet  again,  this  same  Province  of  Manitoba 
guarantees  some  subsidiary  bonds  of  the  Great  Northern 
Railway.  In  South  America  there  are  instances  of 
guarantee  by  government. 

Pure  guarantees  by  municipalities  are  few.  In  a 
measure,  pledging  of  faith  and  credit  of  a  city  and 
county,  as  is  occasionally  done,  for  bonds  of  a  county  in 
which  a  large  city  is  located,  acts  as  such.  Or,  again, 
a  city  may  guarantee  some  of  its  assessment  bonds, 
which,  as  is  well  known,  are  payable  by  special  assess- 
ment on  the  property  benefited.  But  most  rare  of 
all,  is  the  position  of  an  eastern  city  which  endorses 
the  first  mortgage  bonds  of  a  railroad  to  a  certain 
amount.  Exactly  the  reverse  is  occasionally  done 


130  Investment  Bonds 

where  a  municipality  might  issue  bonds  for  say  a 
bridge.  The  street  railway  enjoying  its  use  would 
assume  the  bonds  entirely. 

Guarantee  is  a  form  of  contract ;  involving  as  such  a 
consideration;  some  reciprocal  advantage  to  be  de- 
rived from  the  agreement  by  each  party.  Its  nature 
is,  of  course,  as  diverse  as  the  circumstances  from  which 
it  is  an  outgrowth.  Aside  from  the  legal  necessity  of 
consideration  in  a  valid  contract,  there  must  be,  in 
reason,  a  return  for  so  valuable  a  service.  Whether 
direct  or  indirect,  depends  much  upon  the  nature  of 
the  agreement.  A  direct  benefit  would  be  seen  in 
terms  of  a  specific  consideration;  as,  for  instance,  a 
road  or  company  might  guarantee  another's  bonds  in 
return  for  a  large  block  of  its  stock.  In  a  newly  formed 
corporation,  this  could  well  be  done.  Or  in  the  case 
of  a  leased  or  controlled  line  definite  privileges  or 
earnings  may  be  mentioned.  Often  the  consideration 
is  covered  by  so  indefinite  an  expression  as  * '  one  dollar 
and  other  good  and  valuable  considerations."  Par- 
ticularly is  this  used  where  a  newly  constructed  branch 
line  is  involved,  and  it  is,  of  course,  just  as  effective 
as  though  more  were  said  and  inclusive  of  all  advan- 
tages from  an  interchange  of  traffic. 

Perhaps  the  most  interesting  phase  of  guarantee 
is  its  effect  on  the  bonds  and  its  value  as  an  element 
of  security.  Even  though  the  bond  is  not  primarily 
secured  by  a  mortgage,  guarantee  may  make  an 
excellent  investment  of  one  otherwise  doubtful,  and 
give  to  it  a  standing  of  high  respectability  in  market 
quotation. 

Too  much  emphasis,  however,  is  often  put  on  the 
guarantee;  the  assumption  is  that  in  this  fact  alone 
lies  almost  absolute  safety.  This  is  a  mistake.  There 


Guarantee  131 

must  be  some  inherent  merit  since  repudiation  of 
guarantee  has  sometimes  occurred  where  a  large  road 
guaranteed  the  bonds  of  a  smaller  one.  Hence  it  is 
necessary  that  the  position  and  prospects  of  the  smaller 
one  be  considered.  Its  business  may  dwindle  or 
other  conditions  may  arise  in  which  the  guarantor 
would  lose  heavily  in  caring  for  continued  deficits,  and 
with  some  self-justification  refuse  to  continue  pay- 
ments. Recourse  to  law  would  secure  to  the  holder 
some  satisfaction,  but  in  the  end,  be  efficacious  only 
to  the  extent  that  the  company  could  not  justify  its 
action  in  the  courts. 

Two  things,  therefore,  must  be  kept  in  view  when 
considering  guaranteed  bonds  from  the  standpoint  of 
security ;  the  measure  of  inherent  worth — to  be  judged 
largely  as  of  unguaranteed  issues — and  that  the 
guarantee  is  only  as  good  as  the  giver. 

So  let  the  investor  look  into  the  matter  of  considera- 
tion and  understand  what  conditions  exist;  let  him 
know  that  the  value  of  the  guarantee  behind  the  bonds 
must  be  considered  in  the  light  of  the  integrity  of  the 
company  giving  it  and  that  the  guarantor's  reputa- 
tion for  meeting  its  obligations  is  a  vital  point.  Good 
faith  and  solvency,  in  the  eyes  of  the  financial  world, 
are  the  basis  of  worth. 

The  manner  in  which  guarantee  is  given  and 
carried  out  is  similar  in  all  cases.  Its  authoriza- 
tion, as  with  many  other  corporate  proceedings, 
emanates  from  the  stockholding  body,  and  a  record 
kept  shows  all  its  provisions.  The  language  may 
be  very  simple  or  yet  so  worded  as  to  be  abrogated 
if  desired. 

The  following,  made  by  a  prominent  industrial 
concern,  is  a  good  example: 


132  Investment  Bonds 

Guarantee  of  the  A.  B.  &  C.  Company 

New  York,  January  ist,  1905. 

For  value  received,  The  A.  B.  &.  C.  Company  hereby 
guarantees  the  punctual  payment  of  the  principal  and 
interest  upon  the  within  bond  at  the  time  and  in  the  manner 
therein  specified,  without  recourse,  however,  to  any 
director,  officer,  agent,  or  stockholder  of  said  A.  B.  &  C. 
Company  for  any  purpose  or  upon  any  ground. 

In  this  case  it  is  signed  by  the  Vice-President  and  wit- 
nessed by  the  Secretary  of  the  company. 

Being  a  contract,  it  is  made  either  with  the  bond- 
holder direct,  or,  more  often,  with  the  trustee  for 
him.  If  new  bonds  are  involved,  such  as  those  for 
building  a  branch  line,  the  guarantee  is  generally 
incorporated  in  the  text.  Old  bonds  are  usually  en- 
dorsed to  the  effect  by  stamping. 

One  noteworthy  feature  of  some  guarantees  is  best 
shown  by  citing  the  case  of  the  Central  Vermont  Rail- 
way Company  bonds,  brought  into  the  New  York 
market  a  few  months  ago.  They  are  guaranteed  by 
the  Grand  Trunk  Railway  and  for  all  sums  advanced 
by  that  company  under  the  guarantee,  in  case  of  de- 
fault, it  is  entitled  to  receive  an  equal  amount  of  in- 
terest coupons,  which,  in  case  of  foreclosure,  are 
entitled  to  payment  but  not  until  after  the  principal  of 
the  debt  and  all  other  unpaid  coupons  have  been  paid 
in  full. 

In  this  way  interest  is  paid  yet  the  coupons  are  not 
cancelled.  If  the  position  of  these  coupons  is  not 
clearly  stated,  as  in  this  instance,  the  practical  effect 
is  to  keep  alive  an  interest  lien  which,  at  maturity,  is 
legally  entitled  to  rank  with  the  bonds  in  a  claim  upon 
the  property. 


CHAPTER  XII. 

MATURITY. 

DISCUSSING  the  matter  of  security,  the  permanency 
of  a  bond  was  mentioned.  Investors  demand  stability, 
not  only  in  a  financial  sense,  but  in  a  physical  way,  so 
that  length  of  life  is  a  cardinal  consideration  with  them, 
and  the  long  term  obligation  recommends  itself  gener- 
ally, above  one  of  fewer  years.  The  period  of  life  is 
an  essential  factor  in  establishing  the  return  to  be 
received.  Return  on  a  security  involves  several  fac- 
tors— interest  is  one,  maturity  another,  and  these  in  :/ 
combination  with  market  conditions  produce  a  further, 
price — all  of  which  enter  into  the  mathematical 
computation. 

Their  importance  in  this  is  exactly  known  but  their 
mutual  effects  cannot  be  definitely  measured.  How 
great  a  force  in  the  destinies  of  an  issue  they  individu- 
ally are,  is  uncertain.  The  fact  remains  that  maturity 
is  consequential  apart  from  its  mathematical  aspect, 
and  will,  in  no  small  measure,  determine  the  premium 
or  discount  on  a  bond. 

All  bonds,  save  the  few  perpetual  issues,  some  of 
railroads  and  those  of  states,  generally  issued  for 
educational  purposes  and  irredeemable,  being  held  in 
special  funds  permanently,  have,  as  a  part  of  the  con- 
tract, a  date  set,  on  which  the  principal  will  be  repay- 

133 


134  Investment  Bonds 

able;  this  is  nominal  maturity  and  is  usually  on  an 
interest  date. 

If  the  issue  be  one  secured  by  a  mortgage,  at  that 
time,  on  payment  of  principal  and  interest,  the  mort- 
gage is  satisfied  of  record  by  the  trustee  and  the  bonds 
are  cancelled.  After  payment,  and  cancellation,  the 
bonds  may  be  burned  in  the  presence  of  the  trustee 
and  a  cremation  certificate  executed  and  acknowledged. 

A  slight  variation  in  the  average  maturity  for  each 
class  of  corporation  is  noted,  the  class  to  account  for 
it.  Generally  speaking  railroad  issues  are  longest, 
many  of  which  are  for  fifty  years;  some  shorter  and 
others  for  even  greater  time.  For  distant  maturity 
the  most  unique  obligation  of  this  character  is  the  West 
Shore  Railroad  Company  first  mortgage,  four  per  cent, 
issue,  guaranteed  by  the  New  York  Central  and  running 
until  the  year  2361.  Industrial  bonds  are  apprecia- 
bly shorter,  averaging  not  more  than  twenty  years. 

Actual  expiration  of  an  issue  and  payment  of  the 
debt  it  represents  is  comparatively  rare.  The  Govern- 
ment and  municipalities  from  time  to  time  have  issues 
that  have  run  full  time  and  are  then  paid,  but  railroads, 
who  furnish  the  bulk  of  bonds,  seldom  have  an  issue 
provided  for  in  that  manner.  It  should  be  understood 
that  many  come  to  full  maturity,  so  far  as  time  is 
concerned,  but  through  the  process  of  refunding,  in 
/  one  form  or  another,  the  debt  is  continued,  in  new 
issues  of  securities  perhaps  identical  in  many  particu- 
lars with  the  preceding  issue.  We  are,  however,  here 
concerned  only  with  an  original  bond,  so  to  speak, 
with  a  nominal  lifetime. 

Though  maximum  maturity  may  be  clearly  stated, 
for  obvious  reasons,  hundreds  of  issues,  wholly  or  in 
part,  are  subject  to  much  shorter  existence;  their  real 


Maturity  135 

termination,  in  fact,  is  contingent  on  various  circum- 
stances.    Let  a  long  issue  run  to  full  maturity  and  it ' 
shifts  a  burden  on  future  generations. 

But  a  corporation  may  feel  strong  confidence  in  its 
ability  to  pay  off  a  portion  of  its  debt  before  so  many 
years;  it  may  have  in  mind  a  possible  rearrangement 
of  its  finances  within  a  few  years.  Anticipating  such 
or  other  conditions,  it  reserves  to  itself  a  right  to  reduce 
or  liquidate  the  debt.  Of  some  municipalities  it  is 
required  by  law  that  a  certain  amount  of  debt  shall  be 
annually  retired.  For  such  reasons  bonds  may  actu- 
ally mature  as  affecting  the  investor,  long  before  the 
stipulated  date. 

This  process  of  redemption  is  effected  in  many  ways, 
its  details  varying  with  conditions.  First  of  all,  there 
is  proper  authorization,  as  with  guarantee.  Financial 
provision  for  taking  up  the  redeemed  bonds  is  made  as 
best  suits  the  interests  of  the  corporation;  money  is 
drawn  from  specific  sources  or  taken  from  general 
income  and  usually  designated  as  a  Sinking  Fund. 

Two  general  methods  are  in  use  to  retire  bonds  by 
redemption.  One  is  to  take  them  up  by  lot,  which  is 
to  draw  from  the  numbers  representing  the  entire  issue 
as  many  as  may  be  required.  That  this  operation 
may  never  be  questioned,  it  frequently  is  done  in  the 
presence  of  certain  persons  or  a  notary  public.  Neces- 
sarily a  bond  so  treated,  is  very  uncertain  in  life  and 
therefore  meets  with  objections  from  an  investment 
standpoint.  So  seriously  do  these  objections  affect 
the  bond  that  another  operation,  that  of  purchasing  in  ' 
the  open  market  is  frequently  carried  out.  The  per- 
mission for  this  may  be  provisions  in  a  mortgage  which 
may  say  that  the  bonds  shall  not  be  called  but  bought. 

On  the  corporation  side  of  this  proceeding  are  objec- 


136  Investment  Bonds 

tions  to  be  considered.  An  artificially  high  price  may 
be  created  by  such  purchase  so  that  it  would  be  poor 
policy  to  redeem  them  at  all,  because  such  attempt 
would  be  practically  thwarting  a  corporation  in 
efforts  to  retire  its  obligations.  But  that  such  ad- 
vantage may  not  be  taken  by  holders  many  bonds  are 
often  sought  first  by  purchase  and  that  failing,  are 
drawn  at  a  reasonable  and  stipulated  price. 

Expedients  to  neutralize  the  ill  effect  of  redemption 
are  tried;  for  instance,  with  payment  of  the  bond,  in- 
terest for  a  year  is  given  or  a  percentage  of  the  re- 
maining interest  may  be  added  to  the  principal ;  say  one 
half  of  one  per  cent,  for  each  year  of  the  unexpired 
term. 

Some  bonds  are  very  short-lived;  their  stated  ma- 
turity may  be  twenty  or  more  years  but  the  privilege 
of  redemption  may  be  operative  immediately  and 
at  any  time  thereafter.  Others  are  immune  for  at 
least  a  few  years,  and  others  for  a  certain  time,  with 
some  possibility  that  they  may  run  their  full  length. 
With  some  it  is  specifically  stated  that  they  shall  not 
be  called  until  after  a  certain  number  of  years.  Such 
names  as  five-twenty,  ten-twenty,  or  any  other  com- 
bination frequently  indicate  that  they  will  run  to  the 
first  number  of  years  at  least,  after  which  they  may  or 
may  not  be  exempt  for  the  remaining  time  according 
to  the  special  agreement  made.  In  short,  all  kinds  of 
arrangements  govern  redemption;  it  may  be  yearly, 
semi-annually,  or  at  pleasure;  may  be  on  an  interest 
date  or  other;  may  be  operative  or  void  according  to 
any  number  of  conditions. 

Reserving  the  privilege  of  redemption  for  any  time, 
enables  a  corporation  to  take  advantage  of  low  market 
price ;  at  maturity  par  would  have  to  be  paid ;  if,  before 


Maturity  137 

that  time  the  price  should  fall  below,  it  would  be  a 
saving  operation  to  take  up  as  many  as  possible. 

Amounts  that  may  be  retired  by  redemption  vary,  „• 
being  affected,  of  course,  by  corporate  conditions  or 
the  disposition  of  the  management.  Occasionally  the 
call  privilege  is  exercised  to  redeem  an  entire  issue; 
indeed,  it  may  be  so  provided  that  no  alternative  exists 
if  any  bonds  are  to  be  withdrawn.  General  practice, 
however,  permits  either  all  or  part,  and  this  part  may 
be  further  specified  to  be  a  definite  amount  or  a  certain 
percentage  of  the  whole  issue  or  of  those  outstanding. 
Arrangement  is  sometimes  made  whereby  increasing 
amounts  may  be  redeemed  each  year;  another  retires 
them  so  that  the  debt  will  be  fully  liquidated  by  ma- 
turity, and  still  another  is  to  alternate  in  amounts  each 
year. 

For  reasons  already  suggested,  it  is  the  part  of  wis- 
dom to  set  a  price  at  which  the  bonds  may  be  retired, 
and  that  is  the  custom.  This  price  is  usually  slightly 
higher  than  par  but  may  be  at  the  market.  While  re- 
demption is  usually  accomplished  at  regular  intervals, 
in  many  instances  it  is  a  contingent  operation;  funds 
may  be  at  hand  but  instead  of  adopting  either  method 
already  described,  holders  are  invited  to  bid  for  sur- 
render of  their  bonds  at  prices  named  by  themselves, 
and  in  the  event  of  unsatisfactory  bids,  the  company 
may  not  redeem  any. 

All  this  is  done  through  the  medium  of  advertise- 
ment; public  notice  is  given  in  this  manner  in  which 
all  points  are  covered.  The  length  of  this  notice  is  not 
uniform;  ninety  or  sixty  days  may  be  deemed  neces- 
sary, while  a  month  or  less  is  considered  sufficient  and 
reasonable  for  some. 

Continuation  of  debt  by  refund  into  new  bonds  is   / 


138  Investment  Bonds 

generally  accomplished  with  facility  and  is  common, 
but  actual  extension  of  the  maturity  is  not  widely 
practiced.  Moreover,  many  an  issue  is  hedged  about 
by  restrictions  that  prevent  such  a  proceeding.  In  any 
event,  a  prerequisite  is  consent  of  the  bondholders,  as 
it  is  impossible  for  stockholders  to  take  arbitrary  ac- 
tion in  the  matter.  If  this  consent  partakes  of  the 
nature  of  a  concession  to  the  obligor,  bondholders 
agreeing  to  such  extension  may  receive  compensation. 
An  instance  of  this  is  found  in  the  bonds  of  the  Atlanta 
&  Charlotte  Railway,  a  leased  line  of  the  Southern 
Railway,  which  fell  due  January  i,  1907,  and  which 
would  have  been  refunded,  but  on  account  of  the  un- 
satisfactory state  of  the  bond  market  were  extended 
to  January  ist,  1910,  three  quarters  of  one  per  cent, 
in  cash  being  given  as  compensation. 

A  particularly  long  extension  in  further  illustration 
of  this  method  is  that  of  Missouri  Pacific  former  seven 
per  cents.,  which  fell  due  on  November  i,  1906,  but 
were  prolonged  for  thirty-two  years  at  four  per  cent. 
At  the  time  of  that  extension  a  payment  of  five  dollars 
in  cash  was  made  on  each  bond. 

Apart  from  financial  considerations,  there  is  a 
measure  of  economy  in  such  a  course;  extended  secur- 
ities require  only  new  coupon  sheets  and  perhaps  the 
extension  contract  to  be  attached,  and  where  the 
purpose  is  thus  served,  the  labor  and  expense  of  new. 
securities  is  saved. 

A  unique  extension  arrangement,  making  the  bonds 
practically  perpetual,  is  that  of  a  large  Canadian  road 
with  one  of  its  subsidiary  lines ;  there,  the  holders  have 
agreed  to  refrain  from  demanding  their  principal  during 
the  continuation  of  the  lease  which  is  in  perpetuity. 

The  principle  of  redemption  is  no  different  than  that 


Maturity  139 

underlying  what  is  known  as  the  serial  method  of 
maturing  bonds  where  an  issue  is  divided  into  series, 
each  designated  by  progressive  letter  or  number  and 
coming  to  maturity  in  this  manner.  The  processes  are 
alike  in  essence  but  differ  in  that  the  former  does  not 
nominate  the  specific  bonds  that  shall  be  retired  but 
leaves  it  to  the  accident  of  chance  which  may  fall  up- 
on any,  while  serially,  the  life  of  every  bond  is  defin- 
itely known.  In  effect,  such  a  serial  issue  is  a  number 
of  small  issues  of  different  maturities,  taking  the  nature 
of  short  and  long  term  securities.  Recognizing  this 
fact,  the  market  accepts  them  and  judges  accordingly. 
The  quotation  for  an  early  series  will  often  be  wide 
of  a  later  one. 

As  to  the  periods  in  which  the  series  mature,  they 
vary  as  greatly  as  in  redemption.  Municipalities 
generally  put  the  last  series  of  their  issues  at  many 
years,  twenty  or  more — but  other  corporations  shorten 
theirs.  Railroads,  as  a  rule,  pay  off  say,  one  twentieth, 
twenty-second  or  twenty-fourth  every  six  months  so 
as  to  retire  the  last  not  later  than  twelve  years  from 
date,  and  a  few  are  made  to  mature  in  monthly  instal- 
ments. These  are  well-nigh  requirements,  since  the 
depreciation  of  their  security,  cars  and  equipment,  is 
rapid  and  the  value  of  these  things  is  greatly  reduced 
within  a  comparatively  short  time. 


CHAPTER  XIII. 

MORTGAGE. 

REFERENCE  has  already  been  made  to  this  instru- 
ment, which  so  frequently  plays  an  important  part  in 
the  consummation  of  a  bond  issue.  Its  comparison 
with  the  ordinary  mortgage,  covering  a  piece  of  real 
estate,  shows  them  to  be  built  upon  the  same  principle 
but  structurally  different.  Alike  in  that  their  func- 
tion is  to  provide  security  for  bonds,  they  must 
necessarily  differ  in  other  respects. 

The  parties  of  an  ordinary  mortgage  are  the  obligor 
and  obligee — debtor  and  creditor — but  this  is  a  prac- 
tical impossibility  with  a  large  mortgage,  the  bonds 
representing  which  are  held  by  thousands,  and  are 
being  constantly  negotiated  through  the  exchanges  or 
otherwise.  The  party  of  the  second  part  is  therefore 
-/  a  trustee,  generally  a  trust  company.  Issued  in  this 
way  the  mortgage  becomes  an  indenture,  or  deed  of 
'  trust,  an  agreement  between  two,  under  seal,  for  the 
benefit  of  a  third  party. 

An  ordinary  mortgage  conveys  title,  conditionally, 
of  course,  to  the  obligee,  whereas  by  this  deed  of  trust, 
title  to  the  underlying  property  is  vested  in  the  trustee 
for  the  good  of  all  the  bondholders. 

As  an  example  of  completeness,  this  instrument,  as 
now  usually  drawn,  is  unsurpassed;  every  conceivable 

140 


Mortgage  141 

point  affecting  the  company,  bondholder,  stockholder, 
and  trustee  is  covered  with  minutiae  familiar  only  to 
the  law.  Its  comprehensiveness  embraces  the  interests 
of  all  and  provides  for  every  present  circumstance  and 
many  possible  contingencies. 

Out  of  this  arises  its  complexity.  Not  one  of  every 
one  hundred  bondholders  of  a  large  issue  ever  reads 
through  the  document  on  which  he  so  largely  relies  for 
protection.  Indeed,  without  a  fair  knowledge  of  the 
corporation's  affairs  and  ability  to  interpret  correctly 
a  finely  written  construction,  he  would  have  difficulty 
in  defining  his  position. 

The  necessities  of  the  case  generally  demand  such  a 
document.  Many  things  must  be  considered.  The 
property,  in  its  entirety,  may  be  the  result  of  linking 
and  interlinking  of  others,  each  of  which  has  a  status, 
and  furthermore,  omissions  might  prove  embarrass- 
ing should  trouble  arise  at  some  future  time. 

Because  complex,  it  is  manifestly  of  considerable 
length.  Naturally,  this  varies  with  conditions;  the 
mortgage  on  a  small  subsidiary  company  of  one  hundred 
miles  may  not  be  only  one  one-hundredth  of  the  length 
of  one  on  the  large  system  of  ten  thousand  miles,  but 
it  may  be  comparatively  brief.  A  large  mortgage 
from  cover  to  cover  may  be  fifty  thousand  words  and 
many  contain  half  that  number. 

The  modern  railroad  mortgage  indenture  is  the  acme 
of  legal  finesse  in  construction  and  phraseology  and  is 
the  product  of  accumulated  experience  and  resourceful 
legal  minds.  Its  language  is  exact  and  strong,  elimin- 
ating all  possibilities  of  doubt,  though  often  obscure 
to  a  layman.  Prepared  with  great  care,  it  is  intended 
to  be  beyond  criticism  in  accomplishing  its  purpose. 

Notwithstanding  all,  this  document  has  come  to  be  . 


142  Investment  Bonds 

almost  uniform  in  its  general  plan.  Evolution  has 
brought  it  to  a  point  where  a  blank  form,  modelled 
after  an  accepted  pattern,  could  well  be  used  in  cases. 1 
While  its  general  provisions  in  different  instances  are 
essentially  alike,  the  exact  provisions  frequently  and 
necessarily  must  differ.  Obviously  no  two  could  be 
exactly  alike;  a  power  company  mortgage,  for  instance, 
would  differ  greatly  in  detail  from  that  of  a  railroad; 
those  of  a  candy  factory  and  electric  light  plant  would 
hardly  be  interchangeable. 

An  analysis  of  the  most  approved  form  reveals  the 
safety  of  the  bondholder  most  conscientiously  provided 
for,  in  so  far  as  it  lies  within  the  power  of  the  instru- 
ment; his  rights  are  clearly  and  fully  defined.  Indeed, 
it  behooves  the  corporation  to  recognize  the  urgency  of 
this,  for  a  mortgage  loosely  drawn  can  be  a  decided 
detriment  to  the  bonds  even  if  not  entirely  preventing 
marketing  them. 

Over  against  this  is  the  position  of  the  company ;  that 
too  is  sharply  outlined — its  rights,  reservations,  and 
obligations  are  in  definite  terms.  A  statement  of  the 
position  of  the  company  involves  its  owners,  the  stock- 
holders. However  vigorous  therefore  the  language  of 
the  document,  it  cannot  go  beyond  the  limits  of  justice. 
Though  the  bondholder  is  a  creditor  with  preference, 
and  his  claim  supported  by  a  lien,  the  mortgage  is 
usually  drawn  to  be  fair  and  reasonable;  taking  cog-, 
nizance  of  the  equities  of  the  stockholders. 

Furthermore,  the  document  is  generally  very  ex- 
plicit in  everything  that  appertains  to  the  trustee. 

'  The  New  York  Trust  Company,  formerly  the  New  York  Se- 
curity &  Trust  Company,  has  in  print  such  a  model,  prepared  for  its 
clients  and  those  who  desire  to  prepare  mortgages  under  which  that 
company  is  to  act  as  trustee, 


Mortgage  143 

Responsibility  of  trusteeship  is  the  performance  of 
duties,  more  or  less,  as  the  circumstances  may  require, 
and,  while  legal  liabilities  imposed  upon  the  trustee 
may  be  light  and  specifically  limited,  a  great  weight 
of  moral  accountability  rests  therein.  From  this 
view-point,  a  trustee  could  not  be  held  above  reproach 
should  deception  or  evasion  in  the  terms  of  the  mort- 
gage be  overlooked.  In  a  large  measure,  the  con- 
fidence of  investors  is  in  trust  as  well  as  their 
mortgage  or  property. 

The  general  arrangement  of  the  provisions  of  a  cor- 
porate mortgage  is  about  as  follows: 

DATE. 

PARTIES:  The  corporation  is  here  made  the  party 
of  the  first  part  with  the  trustee  as  of  the  second  part. 

PREAMBLE  :  In  which  are  recitals  of  the  legal  status 
of  the  company  and  its  incorporation,  showing  it  is 
organized  and  existing  under  the  laws  of  whatever 
State  is  proper;  that  it  has  a  certain  amount  of  capital 
stock  and  bonds  and  owns  certain  properties,  lines  of 
railway  etc.  etc.  Also  the  purpose  or  purposes  to 
which  the  proceeds  of  the  bond  issue  are  to  be  applied, 
which  may  be  stated  specifically  or  generally. 

Corporate  authority  for  the  issuing  of  the  bonds  and 
execution  of  the  mortgage  is  found  in  a  copy  of  the 
resolution  of  the  stockholders  authorizing  the  directors 
to  proceed,  together  with  a  copy  of  the  directors'  reso- 
lution in  the  matter.  This  resolution  generally  recites 
it  has  been  decided  to  issue  such  an  amount,  at  such  a 
rate,  maturing  such  a  time  etc. 

FORM  OF  BOND  :  Full  text  of  the  bond  is  given ;  if  in 
both  registered  and  coupon  form,  both  are  given  in  full. 

FORM  OF  INTEREST  COUPON:  Exact  copy  of  this 
generally  follows  the  form  of  bond. 


144  Investment  Bonds 

TRUSTEE  CERTIFICATE:  Form  of  this  certificate  of 
validity  given  in  full. 

GUARANTEE:  If  bond  is  guaranteed,  form  of  guar- 
antee by  the  third  party,  in  full  text,  may  be  given  in 
the  mortgage. 

GRANTING  CLAUSE:  Transfers  the  property  to  the 
trustee  to  secure  the  payment  of  the  bonds;  generally 
an  absolute  transfer. 

PROPERTY  MORTGAGED:  Full  description  of  prop- 
erty included  under  the  mortgage  is  herein  given.  If 
it  is  to  cover  securities — stocks  and  bonds — an  itemized 
list  of  these  is  generally  given.  In  many  cases  other 
liens  exist,  in  which  case  their  status  is  set  forth  showing 
their  priority,  etc.  In  this  provision  is  generally  found 
the  clause  pertaining  to  after-acquired  property,  stating 
whether  that  shall  come  under  the  present  mortgage. 

TRUSTEESHIP:  Stating  that  the  property  is  granted 
only  in  trust  and  for  the  equal  pro  rata  use,  benefit, 
and  security  of  all  holders  or  owners  of  said  bonds. 

CERTIFICATION  :  Provides  for  certification  and  proper 
issue  of  bonds  and  emphasizes  necessity  of  the  trustee's 
certificate  of  validity. 

OVERDUE  COUPONS  :  Providing  for  cancellation  and 
delivery  to  the  mortgagor  company  of  all  coupons 
which  are  matured  at  the  time  of  delivery  of  any  bond. 

COVENANT  TO  PAY  BONDS  :  Mortgagor  agrees  that 
it  will  promptly  pay  interest  and  the  principal  of  bonds 
hereby  secured  at  the  time  and  in  the  manner  specified 
in  said  bonds  and  coupons. 

INSURANCE,  TAXES,  ASSESSMENTS,  ETC.:  Compels 
the  mortgagor  to  keep  the  property  insured — pay  the 
insurance  charges,  promptly  pay  and  meet  all  taxes, 
rates,  levies  or  assessments  and  charges  so  that  the 
lien  may  remain  unimpaired. 


Mortgage  145 

INTEGRITY  OF  LIEN:  Binds  the  company  to  do  all 
things  necessary  to  preserve  and  keep  valid  the  lien 
hereby  created,  making  it  also  necessary  to  keep  the 
mortgage  a  prior  lien. 

CONTROL:  Recitation  that  the  company  shall  re- 
tain a  complete  control  and  fully  enjoy  the  profits, 
etc.,  of  the  property  until  default  shall  occur. 

REGISTRATION:  Provision  is  usually  made  for  regis- 
tration of  principal  of  coupon  bonds;  sometimes  for 
registration  of  interest. 

OFFICE  :  Place  of  payment  of  coupons,  generally  in 
New  York,  is  here  provided;  also  for  the  service  of 
any  legal  demands  by  the  bondholders. 

SUBSIDIARY  COMPANIES:  As  many  companies  have 
numerous  subsidiary  companies,  the  status  of  each 
one  of  these  and  the  position  of  their  securities  is 
definitely  stated. 

DEFAULT:  States  what  shall  constitute  default; 
specifies  how  long  a  period  shall  have  passed  in  default 
before  any  action  may  be  taken;  specifies  what  shall 
be  the  trustee's  duties  as  to  taking  possession  of  the 
property  and  operating  it  for  the  benefit  of  the  bond- 
holders; designates  what  percentage  of  the  bond- 
holders must  request  action  on  the  part  of  the  trustee 
to  enforce  their  rights.  This  percentage  may  be 
twenty-five,  usually  not  more.  Then  follow  duties  of 
trustee  in  case  of  sale  and  percentage  of  bondholders 
necessary  to  compel  this  action.  The  question  of  sale, 
however,  must  be  decided  by  a  majority  of  bondholders. 

FORECLOSURE:  Duties  of  trustee  in  the  event  of 
foreclosure  and  sale  follow,  and  percentage  of  bond- 
holders necessary  to  compel  this  action  is  stated. 
Usually  it  must  be  a  majority.  All  judicial  proceed- 
ings are  provided  for  and  all  receivership  matters. 


146  Investment  Bonds 

TRUSTEE,  CHANGE  OF:  Provides  for  resignation  of 
trustee  at  any  time  after  having  given  due  notice ;  also 
for  removal  of  trustee  upon  written  wish  of  a  majority 
of  bondholders;  also  for  appointment  of  a  successor. 

TRUSTEE,  RESPONSIBILITY  AND  LIABILITY  OF:  Sets 
forth  terms  and  conditions  upon  which  trustee  accepts 
the  trusts  and  assumes  the  duties  imposed  by  the 
mortgage;  gives  a  lien  on  the  property  as  compen- 
sation for  execution  of  the  trusts. 

OFFICERS  AND  DIRECTORS,  LIABILITY  OF:  They 
are  absolved  from  any  personal  liability  by  reason  of 
the  obligations  of  the  indenture. 

INTERPRETATION:  This  is  to  give  construction  on 
the  terms  used  in  the  instrument  so  that  the  text 
may  be  open  to  no  question  on  that  point.  It  men- 
tions a  few  words  used  throughout  the  mortgage 
and  explains  their  meaning,  indicating  how  others 
shall  be  interpreted. 

COUNTERPARTS:  To  expedite  recording  of  the  in- 
denture a  number  of  originals  are  simultaneously 
executed,  acknowledged,  and  delivered,  and  all  con- 
sidered as  one  and  the  same  instrument. 

The  preparation  of  the  mortgage  is  the  work  of 
counsel  highly  skilled  in  corporate  law;  and  only  the 
best  talent  in  this  line  is  employed.  They  must  not 
only  build  the  document  but  must  declare  its  legality, 
as  it  must  conform  with  all  provisions  of  the  company's 
charter  relating  thereto,  and  must  not  conflict  with 
any  laws  of  the  State  in  which  the  company  is  in- 
corporated, or  of  the  United  States. 

After  all  this  is  completed,  it  is  duly  signed  by  the 
President  of  the  company  followed  by  the  signature  of 
the  Trustee,  thus  acknowledging  the  trusts  imposed. 
The  corporate  seals  of  both  company  and  trustee  are 


Mortgage  147 

affixed  and  attestation  is  made  by  the  respective  sec- 
retaries. However,  before  it  is  accepted,  counsel  of 
the  trustee  make  a  very  careful  study  of  its  contents. 
Not  always  is  it  accepted  in  its  original  form.  As 
a  general  rule,  trust  companies  require  certain  essentials 
to  be  incorporated  and  it  is  frequently  changed  to  meet 
their  views,  that  they  may  feel  fully  secure  in  accepting 
the  trusteeship  and  the  responsibility  of  issuing  the 
bonds. 

The  provision  for  more  than  one  copy  arises  from 
the  necessity  of  recording.  Some  companies  must  ob- 
serve this  formality  in  several  States,  which  is  greatly 
facilitated  b^i  this  provision.  In  all  cases  it  must 
be  recorded  with  the  Secretary  of  each  State  affected, 
and,  if  it  be  a  railroad,  with  the  proper  official  of 
every  county  traversed. 

Consolidation,  extension,  lease,  purchase,  mort- 
gaging and  remortgaging  have  so  multiplied  the  liens 
on  large  railroad  systems,  in  part  and  entirety,  that 
memory  cannot  well  retain  their  number  and  relative 
position.  To  facilitate  the  banker's  work  in  con- 
sidering flotation  of  new  issues  and  to  assist  investors 
in  judgment,  pictorial  representations  of  all  mortgages 
on  most  railway  lines  are  published.  When  it  is  con- 
sidered that  the  Pennsylvania  Railroad,  for  instance, 
has  outstanding  upwards  of  two  hundred  and  fifty 
issues  of  all  kinds  and  conditions,  the  usefulness  of 
such  a  publication  is  appreciated. 

Like  wills,  many  mortgages  are  subject  to  amend- 
ment and  qualifications ;  changes  in  business  conditions 
often  require  modifications  to  the  original  document 
and  a  supplementary  indenture  is  therefore  generally 
issued.  An  infinite  variety  of  circumstances  may 
give  rise  to  this  procedure;  in  fact,  almost  any  varia- 


148  Investment  Bonds 

tion  of  the  terms  is  covered  by  supplementary  inden- 
ture. If  the  security  of  bonds  is  at  all  affected,  it  is 
invariably  done.  Yet  there  is  a  distinction  between 
supplementary  indentures  and  plain  supplementary 
agreements',  their  effect,  to  modify  the  original,  is 
identical,  but  the  latter  are  less  formal  documents.  In 
construction  both  may  be  brief  or  full,  as  the  case 
warrants.  Their  relative  importance  is  indicated  by 
the  manner  of  execution.  Supplementary  indentures, 
as  with  originals,  require  proper  authorization  by  the 
stockholders  and,  further,  by  the  bondholders.  The 
value  of  such  a  requirement  is  more  than  self-evident ; 
but  for  it,  the  security  of  their  position  might  be 
greatly  altered. 

Supplementary  agreements  are  comparatively  in- 
formal ;  only  minor  points  are  generally  affected,  hence 
the  approval  of  the  bondholders  is  not  sought.  If 
their  trustee  deems  it  not  inimical  to  their  interests, 
that  is  sufficient  and  fully  effective. 

While  not  all  supplementary  indentures  radically 
change  the  terms  of  the  originals,  those  resulting  from 
reorganization  generally  do.  But  with  assumed  bonds 
the  essential  elements  may  remain  unchanged,  the  fact 
of  a  new  obligor,  alone,  necessitating  the  later  docu- 
ment. Or  again,  new  or  more  property  may  be  in- 
cluded in  the  lien,  simultaneous  with  the  issue  of  more 
bonds  which,  in  effect,  enlarges  the  scope  rather  than 
alters  the  mortgage. 

The  laws  of  mortgages  fail  of  their  literal  fulfilment 
when  documents  covering  bonds  on  a  large  railroad, 
running  through  several  States,  are  considered.  Some 
uniformity  is  found  in  the  statutes  of  the  several 
States,  but  not  sufficient  to  comprehend  these  broad 
indentures.  Strict  application  of  the  laws  of  one  State, 


Mortgage  149 

in  default  more  especially,  would  destroy  equities  and 
might  disrupt  the  entire  organization.  Consequently 
most  railroad  mortgages  occupy  a  unique  position. 
In  a  sense,  the  precise  terms  of  law  are  superseded  by 
considerations  of  equity,  and  should  it  be  invoked  for 
the  protection  of  bondholders,  the  matter  would  be 
adjudicated  on  that  basis. 

Financially  considered,  mortgages  are  commonly  - 
classified.  Advertisements  enumerating  particulars 
of  an  issue  sometimes  state  that  the  mortgage  is  closed, 
a  fact  that  carries  more  or  less  weight  with  investors. 
Strictly  speaking,  such  a  mortgage  covers  a  stated 
amount  of  bonds,  all  issued  at  once,  and  its  provisions 
are  most  rigid  to  prevent  any  increase.  Thus  is  a 
corporation  restrained  from  incurring  further  indebted- 
ness and  using  the  same  mortgage  as  the  protection. 

But  the  term  is  often  applied  to  what  is  in  reality  a 
limited  open-end  mortgage,  a  type  embodying  some  of 
the  features  of  both  closed  and  open  end.  Its  quasi 
character  embodies  the  desirable  principle  of  restriction 
and  at  the  same  time  gives  latitude  to  the  issuing  com- 
pany, so  that  legitimate  debt  may  be  incurred  and 
growth  and  progress  not  fettered.  Any  inelasticity  in 
the  provisions  of  a  mortgage  is  felt  when  additional 
funds  are  needed  and  if  the  amount  of  bond  issue  cannot 
be  increased,  the  result  is  the  creation  of  new  mortgages 
with  inferior  liens.  Indeed,  the  multiplicity  of  bond 
issues  may  be  attributed  in  no  small  measure  to  this 
fact.  Partly  then  to  avoid  accumulating  junior  liens, 
and  partly  to  provide  for  future  needs,  many  ways  - 
have  been  found  through  these  quasi  open  and  closed 
mortgages.  That  this  is  a  wise  course  is  beyond  ques- 
tion. A  primary  consideration  in  an  analysis  of  a 
new  security  is  its  priority.  Let  there  be  a  multiplica- 


Investment  Bonds 

tion  of  liens,  however  small  and  secure,  the  circum- 
stance creates  a  sentimental  prejudice  against  later 
ones.  Obviously  it  would  be  impolitic  to  create  a  new 
mortgage  each  time  funds  were  needed,  when  the 
amount  is  comparatively  small.  Hence,  the  method 
is  to  provide  for  a  large  amount  with  one  mortgage, 
not  only  to  care  for  the  company's  needs  at  the  time  of 
its  creation  but  for  those  of  the  future  as  well.  In  this 
way  the  corporation  can  secure  funds  for  certain  pur- 
poses without  creating  junior  mortgages. 

But  because  so  much  money  is  not  needed  at  once, 
some  provision  must  be  made  to  prevent  extravagance 
and  to  safeguard  the  interests  of  the  bondholders.  Left 
to  themselves,  with  full  power  to  command  a  great  sum, 
managers  might  not  resist  temptation  to  its  misuse, 
and  so  restrictive  conditions  are  thrown  about  them. 
It  should  be  noted  that  in  total  amount  the  mortgage 
is  indeed  closed,  but  in  the  method  of  its  distribution 
over  a  considerable  number  of  years,  the  last  of  which 
may  be  far  in  the  future,  lies  its  open-end  feature. 
From  all  practical  considerations,  the  initial  investor 
deals  with  an  open-end  instrument.  The  limitations 
imposed,  that  prevent  too  rapid  issue,  are  moulded 
by  circumstances.  Commonly  they  stipulate  certain 
amounts  periodically,  and  may  further  designate  the 
use  of  the  funds.  Yet  such  arrangements  are  found 
as  requirement  of  permission  from  the  syndicate  which 
bought  the  first  amount;  unanimous  consent  of  the 
stockholders;  and  prohibition  of  issuance  in  excess  of 
a  certain  amount  until  full  interest  is  paid  for  some 
preceding  period  on  all  bonds  outstanding. 

If  proper  precautions  are  observed,  there  is  no  valid 
reason  why  bonds  under  this  type  of  mortgage  should 
be  considered  less  desirable  than  others.  Never  the- 


Mortgage  151 

less,  a  few  investors  are  pronounced  in  their  partiality 
for  the  absolutely  closed  type  through  a  lurking  fear 
of  laxity  under  any  other.  The  merit  of  the  closed 
mortgage  situation  is  in  that  the  exact  amount  out- 
standing may  be  easily  kept  in  mind,  and  this  amount 
does  not  grow  with  time.  But  to  regard  it  as  an  instru- 
ment circumscribing  debt-creating  ability  is  to  be  self- 
deceived.  Experience  has  demonstrated  with  what 
comparative  ease  new  liens  (more  especially  the  general 
railroad  type)  may  be  placed  and  the  bonded  debt 
increased. 

There  is  yet  the  open-end  mortgage  to  be  considered. 
Such  a  type ,  under  which  the  amoun  t  of  bonds  issued  could 
be  increased  without  restriction,  per  se,  would,  of  course, 
be  useless — an  impossibility — and  is  therefore  unknown. 
What  is  implied  by  the  term  is  unrestricted  issue  in 
total  amount  only,  somewhat  an  anticipation,  in  effect, 
of  development  and  growth  by  accretion.  But  to  fore- 
stall the  evil  of  unwarranted  issue,  the  property  to  be 
acquired  with  all  bonds  put  out  must  be  in  evidence. 
Railroads,  as  a  rule,  are  alone  in  issue  of  such  mort- 
gages. As  they  build  additional  trackage,  bonds  to  the 
extent  of  a  certain  amount  per  mile  may  be  issued,  from 
which  it  is  seen  that  the  limit  of  total  amount  would 
be  reached  only  when  construction  ceased.  The  force 
of  influence  exerted  by  each  of  these  three  types  of 
mortgage  is  a  question.  On  the  whole  market  the 
effect  of  any  is  very  indirect  and  unappreciable  gen- 
erally. On  its  own  issue,  it  is  felt  though  not  severely. 
For  the  opposite  reason  that  a  few  investors  lean 
toward  the  closed  mortgage,  others  are  prejudiced 
against  the  unlimited  issue  of  the  open-end  because  it 
is  only  with  difficulty  that  they  may  know  the  amount 
in  the  market.  Vigorous  building  operations  by  a 


i52  Investment  Bonds 

railroad  would  necessitate  large  amounts  of  bonds  and 
these,  poured  into  the  market,  would  naturally  tend 
to  depress  the  price.  Held  in  such  disfavor,  but  few 
are  made,  the  prevailing  type  being  what  has  been 
called  limited  open-end. 


CHAPTER  XIV. 

LEASE. 

THIS  is  pre-eminently  a  characteristic  of  American 
railroad  extension.  Before  the  era  of  large  capital 
combinations  many  small  lines  were  constructed; 
local  capital  promoted  comparatively  short  lines  in 
profitable  territory  which  were  operated  more  or  less 
successfully  for  years.  But  the  destinies  of  these  scat- 
tered pieces  of  railroad  were  greater  far.  Though  often 
connected,  it  was  obvious  that  under  separate  organi- 
zations of  management,  their  sphere  of  usefulness  was 
limited,  and  if  local  business  was  unsuccessful  they 
might  easily  prove  to  be  failures.  The  large  cities 
very  often  could  only  be  reached  through  a  chain  of 
connections,  each  a  distinctive  corporate  organization, 
and  administered  under  methods  and  policies  not 
always  in  harmony.  Under  such  conditions,  effi- 
ciency and  economy  of  operation  as  witnessed  to-day 
were  manifestly  impossible. 

The  logical  outcome  was  combination  and  consoli- 
dation. A  separate  identity  was  preserved  in  many 
cases,  but  commercially  there  was  unity.  In  such 
movements  the  largest  and  strongest  company  gener- 
ally became  the  initiator,  and  thus  the  foundation  on 
which  to  build  a  gigantic  structure,  the  great  railway 
system  of  to-day. 

Mention  has  already  been  made  of  the  practical 

153 


154  Investment  Bonds 

community  of  interest  of  sixty-five  per  cent,  of  the 
railways  of  this  country  and  their  control  of  the  re- 
mainder. Differently  expressed,  less  than  ten  systems 
of  railways  in  the  United  States  control  this  large  per- 
centage of  the  whole.  One  or  two  concrete  illustra- 
tions suffice  to  show  from  what  a  little  acorn  this  great 
oak  has  grown.  The  Vanderbilt  system,  embracing 
12,500  miles,  is  the  result  of  a  union  of  seven  small 
roads  between  Albany  and  Buffalo;  and  the  somewhat 
smaller  Atchison  has  grown  from  an  original  line  of 
less  than  one  hundred  to  9,200  miles  of  track.  Yet 
building  of  great  systems  was  not  the  last  step  in  con- 
solidation. Further  than  uniting  groups  of  small 
roads  as  large  systems,  these  systems  have  for  years 
worked  under  traffic  agreements,  varied  in  character, 
but  wholly  beneficial  to  all  concerned.  In  the  com- 
monly accepted  sense  this  is  not  true  consolidation, 
but  so  far  as  shippers  and  the  travelling  public  are 
affected,  it  is  the  same.  The  internal  relations  estab- 
lished by  this  method  vary  but  slightly  from  those 
growing  out  of  traffic  associations.  While  a  traffic 
agreement  may  involve  only  two  systems,  an  associa- 
tion is  the  combination  of  several.  Highly  representa- 
tive of  the  latter  type  is  the  Trunk  Line  Association, 
comprised  of  all  great  lines  running  into  New  York 
City. 

Actual  consolidation,  however,  is  largely  accom- 
;  plished  through  two  methods — ownership  and  lease. 
In  recent  years  these  have  come  to  be  the  most  common 
forms  of  control.  How  the  parent  company  shall 
exercise  this  control  over  its  subsidiary  company  is  a 
question  decided  in  each  case  by  circumstances.  Ab- 
solute ownership  is  not  often  necessary;  moreover,  the 
expense  of  buying  all  its  stock  would  be  great.  So 


Lease  155 

where  this  form  of  control  is  desirable  only  a  majority 
of  the  capital  stock  generally  passes,  or  such  propor- 
tion as  is  requisite  to  accomplish  the  purpose,  that  of 
dictating  the  policy  of  the  line.  An  advantage  to  be 
derived  from  this  method  lies  in  the  benefits  of  a 
possible  greater  prosperity  when  the  benefit  of  an  in- 
crease of  earnings  would  be  reaped  by  the  parent  com- 
pany. The  disadvantage  is  its  indirectness ;  since  every 
move  in  policy  must  have  formal  sanction  by  the  di- 
rectorate of  the  smaller  line  ere  it  becomes  operative. 

But  if  the  same  end  may  be  attained  with  a  minimum 
expenditure  of  funds,  at  the  moment,  and  avoidance 
of  such  formality  of  action,  the  method  of  leasing  is 
certain  to  be  adopted.  Under  the  lease,  plans  for  all 
parts  of  an  entire  system  may  be  executed  with 
great  facility  and  policies  carried  out  with  expedi- 
tion impossible  under  other  conditions.  From  this 
view-point,  the  crowning  feature  of  this  method  is 
its  directness. 

Acquisition  of  mileage  results  from  different  causes. 
It  would  be  erroneous  to  assume  that  natural  growth 
alone  has  been  responsible.  Time  and  again  competi- 
tion has  forced  it.  Not  infrequently  systems  under 
virtual  compulsion  to  take  over  rival  lines  have  merged 
them  by  lease.  Or  again,  aspirations  have  led  a  com- 
pany to  seek  a  desirable  terminal,  the  possession  of 
which  could  be  attained  only  through  control  of  its 
owner. 

What,  then,  is  the  nature  of  this  transaction  of  lease 
which  plays  so  important  a  part  in  the  economics  of 
transportation?  A  fact  to  be  noted  is  that  the  agree- 
ment represented  by  a  document  of  this  name  differs 
essentially  from  a  mortgage.  It  is  between  two  corpo- 
rate bodies,  ratified  by  the  stockholders — owners — of 


156  Investment  Bonds 

each;  the  bondholders — creditors — being  without  voice 
in  the  matter. 

In  the  legal  aspect,  it  approaches  a  type  of  conditional 
deed,  drawn  and  signed  by  the  subsidiary  company, 
transferring  its  line  to  the  parent  company  for  a  number 
of  years.  The  intent,  however,  is  not  transfer  of  title 
but  merely  to  give  permission  to  its  use.  For  the 
benefits  to  be  derived,  generally,  there  must  be  some 
form  of  compensation.  Though  they  be  not  always 
calculable  in  pecuniary  terms,  the  strategic  advantage 
of  a  leased  property  is  sometimes  worth  many  times 
its  cost  or  rental.  Payment  for  lease  is  considered  as 
rental  and  forms  a  very  substantial  item  in  the  annual 
reports  of  most  great  systems.  Variations  in  terms 
governing  the  time  and  amounts  of  payments  are  no 
less  limited  than  the  actual  number  of  leases  that  may 
be  made.  All  sorts  are  drawn,  every  one  adapted  to 
the  special  conditions  of  tenure.  Possibly  best  known 
is  that  wherein  the  lessee  agrees  to  provide  for  interest 
v'on  bonds  of  the  other  company.  Whether  or  not  these 
obligations  are  fully  assumed,  such  rental  payment 
is  equivalent  to  guarantee  of  interest,  hence  the  bonds 
of  a  leased  line  falling  under  such  provisions  are  always 
known  in  the  market  as  guaranteed. 

If  the  lessee  does  not  elect  to  become  owner  by 
purchase  of  all  outstanding  stock,  and  the  earnings  of 
the  property  show  return  on  the  stock,  of  course,  con- 
tinuance of  these  dividends  would  be  a  part  of  any 
agreement  the  stockholders  might  make.  Out  of  this 
proceeding  have  grown  many  issues  of  guaranteed 
stocks.  Therefore,  rental  is  frequently  joint  payment 
of  an  amount  of  dividend  on  the  stock  of  one  kind  or 
another  or  both,  and  also  payment  of  interest  on 
bonds  outstanding.  No  better  random  illustration 


Lease  157 

could  be  cited  than  the  Delaware  &  Hudson  subsidiary 
line,  Albany  &  Susquehanna  Railroad,  where  the  rental 
is  a  round  sum  of  $490,000  per  annum,  part  of  which, 
by  the  terms  of  the  lease,  is  applied  to  retire  $1,000,000 
bonds  of  a  special  issue,  part  to  pay  interest  on  the 
outstanding  bonds,  and  part  to  pay  nine  per  cent, 
dividends  on  the  stock. 

If  dividends  on  stock  are  not  specifically  provided 
for,  a  percentage  more  than  the  interest  on  outstand- 
ing bonds  is  often  stipulated ;  for  instance,  twenty  or 
thirty  per  cent.  Still  other  arrangements  call  for  a 
progressive  rental  that  in  many  cases  is  regulated  by 
the  earnings  of  the  leased  line — it  is  then  made  pro- 
portionate to  either  gross  or  net  earnings.  In  some 
leases  where  a  fixed  annual  rental  is  prescribed,  re- 
gardless of  earnings,  provision  is  inserted  permitting 
readjustment  of  the  amount  after  every  period  of  a 
certain  number  of  years.  The  equity  of  such  an 
arrangement  is  evident — in  a  few  years  a  line  may 
lose  much  of  its  value  to  the  lessee,  who  then,  after 
a  short  time,  has  an  opportunity  to  adjust  his  obliga- 
tion to  his  benefits.  As  is  well  said,  in  one  place  the 
lessee  guarantees  nothing  or  little,  now  much  or  every- 
thing; in  some  instances  he  undertakes  to  make  up  a 
deficiency  under  a  minimum  sum  and  in  others  he 
gobbles  all  the  earnings  above  a  certain  maximum. 

The  great  variety  of  leases  naturally  involves  periods 
of  tenancy  of  different  lengths.  Some  are  so  loosely 
drawn  that  they  may  be  dissolved  practically  at 
will.  Opposite  to  this  is  the  term  of  nine  hundred  and 
ninety-nine  years,  known  as  lease  in  perpetuity.  In- 
voluntary dissolution  of  lease  sometimes  confronts  a 
line;  the  Boston  &  Albany  Railroad,  for  example,  is 
leased  to  the  New  York  Central  with  permission  of 


158  Investment  Bonds 

State  authority,  but  upon  one  fundamental  condition — 
that  it  shall  perform  as  good  service  in  its  new  relations 
as  aforetime.  Alleging  that  this  part  of  the  agree- 
ment had  been  broken,  the  State  of  Massachusetts 
threatened  at  one  time  to  annul  the  lease. 

Diversity  of  motives  in  controlling  properties  ac- 
counts largely  for  the  length  of  leases.  Where  the 
purpose  is  to  develop  a  great  system,  long  agreements 
are  drawn  and  we  have  the  lease  for  two,  three,  five 
hundred  or  practically  a  thousand  years ;  or  in  another 
form,  coterminous  with  the  lessor's  corporate  exis- 
tence. On  the  other  hand,  a  momentary  advantage 
may  be  all  that  is  sought,  which  could  be  gained 
within  a  period  of  ten  or  fifteen  years. 

Termination  of  a  short-term  lease  often  gives  the 
lessee  the  same  opportunity  for  adjustment  which  is 
specially  provided  for  in  some  of  a  longer  period. 
New  values  are  then  put  upon  the  subsidiary  line, 
reflecting  its  usefulness  and  earning  ability,  so  that  if 
extension  of  the  lease  is  made,  a  new  working  basis  is 
established.  Such  readjustment  and  revaluation  oc- 
curs in  every  reorganization.  This  is  a  time  when  all 
agreements  of  this  kind  are  annulled,  and  the  lessee 
is  relieved  from  the  letter  of  the  contract.  Through 
these  proceedings  it  becomes  free  to  discard  a  line 
or  modify  its  agreement  to  its  own  satisfaction.  With 
much  valuable  experience  to  guide,  continuation  of  an 
old  lease  or  creation  of  new  ones  will  be  done  under 
terms  quite  unlikely  to  prove  onerous  or  a  loss. 

Railroad  history  has  many  instances  of  default  of 
lease.  One  large  system  in  the  eastern  half  of  the 
country  is  notoriously  known  for  its  repeated  failures 
to  live  up  to  such  obligations;  it  has  frequently  trans- 
gressed in  this  fashion  when  its  ends  were  served;  yet 


Lease  159 

because  of  its  strength  and  position  nearly  always 
might  made  right,  and  the  aggrieved  parties  generally 
obtained  but  meagre  satisfaction.  To  protect  them- 
selves in  the  event  of  bad  faith,  stockholders  sometimes 
require  guarantee  that  the  lease  will  be  performed  in 
every  provision,  and  if  it  is  not  they  will  receive  com- 
pensation for  damage.  Various  plans  to  this  effect  are  in 
operation.  Under  one,  securities  to  a  specific  amount 
are  deposited  in  trust.  Upon  default  they  are  for- 
feited, if  not  entirely,  at  least  to  the  amount  which, 
upon  adjudication,  shall  represent  the  loss.  Other  plans, 
though  differing  in  detail,  embody  the  same  principle. 
For  obvious  reasons  arrangements  of  this  nature  are 
not  popular  with  lessees;  the  loss  that  would  be  sus- 
tained through  forfeiture  of  a  large  block  of  valuable 
securities,  supplementing  the  loss  through  a  possible 
bad  lease,  is  not  relished  by  any  corporation.  Moreover 
the  corporation  whose  property  is  not  already  mort- 
gaged in  some  degree,  and  therefore  not  available  for 
such  a  purpose,  is  rare. 

The  execution  of  a  lease,  fundamentally,  must  be 
in  strict  accordance  with  the  laws  of  the  home  State, 
that  is,  the  State  of  incorporation  of  the  lessee,  and  it 
must  be  drawn  so  as  not  to  exceed  the  corporate  powers 
of  the  company ;  for  to  go  beyond  these  or  enter  into  a 
transaction  contrary  to  law  is  ground  for  annulment. 

From  the  standpoint  of  its  market  effect  on  bonds, 
little  may  be  added  to  what  has  already  been  said  in 
reference  to  guarantee.  Generally  speaking,  the  les- 
sor's bonds  have  a  prestige  when  behind  them  stands 
a  strong  system  or  company;  a  prestige  that  usually 
carries  them  along  at  a  good  quotation,  a  little  better, 
perhaps,  than  is  justified  by  intrinsic  worth. 


CHAPTER  XV. 

TAXATION. 

BONDS,  stocks,  and  all  similar  securities,  whether 
held  in  the  treasury  of  a  corporation,  as  among  its 
assets,  or  stowed  away  in  the  strong  box  of  a  small  in- 
vestor, are  a  form  of  personal  property  and  under  this 
classification  are  subject  to  the  general  laws  governing 
taxation.  The  purposes  of  taxation,  in  its  various 
phases,  need  no  elaboration,  for  they  are  known.  The 
Government,  the  State,  and  all  minor  civil  divisions 
must  have  revenue  to  maintain  public  works  and  exer- 
cise their  functions  for  advancement  of  the  common 
good. 

Through  the  method  of  levying  on  bonds  as  personal 
property  it  is  possible  to  collect  a  tax  on  them  with 
facility.  Obviously  the  broad  distribution  of  many 
issues  precludes  a  general  application  of  any  other  plan 
such,  for  instance,  as  a  specific  tax  on  specific  issues. 
They  become  scattered  throughout  a  wide  territory, 
embracing  many  States  each  of  which  has  laws  varying 
more  or  less  from  its  neighbors,  so  that  the  only  prac- 
tical way  is  collection  of  the  tax  where  the  bonds  are 
held.  Thus,  while  the  rate  is  always  low,  only  a  few 
mills  generally,  it  is  always  different  according  to  the 
locality. 

Nor  are  the  bonds  of  an  investor  differentiated  from 

160 


Taxation  161 

his  other  personal  property.  At  the  time  of  taxation, 
such  holdings  of  any  description  are  the  subject  of 
valuation  in  gross  amount.  He  may  have  $50,000  in 
bonds  and  $600,000  value  in  other  things  classified  as 
personal.  Assuming  honesty,  the  sum  of  these  would 
be  declared,  on  which,  with  proper  reductions,  the 
tax  would  be  based.  Though  no  items  are  specially 
set  forth,  segregating  as  it  were  the  holdings  of  an 
individual,  the  position  of  corporations,  under  the 
necessity  of  full  reporting  of  security  assets,  is  different. 
Insurance  companies,  savings  banks,  and  all  other  in- 
stitutions of  whom  it  is  required,  show  in  detail  every 
bond  they  own,  thereby  rendering  appraisal  of  their 
value,  for  purposes  of  taxation,  of  easy  accomplishment 
by  the  authorities  when  necessary. 

Here  enter  the  matters  of  premium  and  discount. 
It  might  be  supposed  that  par  value  is  the  basis  of  val- 
uation and  taxation,  but  such  is  not  the  case.  Market 
value,  or,  if  no  quotation  exists,  its  approximation,  is 
the  determining  figure. 

Since  bonds  are  classified  in  common  with  personal 
property,  proceeds  from  their  taxation  are  part  of  the 
common  fund  and  treated  accordingly.  How  collec- 
tion is  made  may  not  be  too  well  understood  to  bear 
repetition.  As  general  practice,  where  a  county  is  v 
large,  scattered  throughout  with  smaller  towns  and  vil- 
lages, each  of  these  has  its  local  collector,  who  receives 
full  taxes  and  after  retaining  the  proper  local  propor- 
tion turns  the  balance  over  to  the  county  treasurer,  who 
in  turn  withholds  county  revenues,  and  the  remainder 
is  finally  passed  to  the  State  authorities.  Where  a 
whole  county  is  within  the  lines  of  a  city,  one  central 
place  of  payment  is  usual,  from  which  all  similar  ap- 
portionment is  made. 


162  Investment  Bonds 

Of  the  billions  of  dollars  of  bonds  in  the  market, 
many  millions  are  relieved  from  the  burden  of  taxation, 
light  though  it  be.  Exemption  from  taxation,  first  of 
all,  is  accomplished  in  a  variety  of  ways,  and  for  several 
reasons,  and  may  be  accorded  either  by  general  statute 
or  through  special  legislation.  Sometimes  bonds  are 
not  exempt  by  general  statute,  so  when  it  is  desired 
to  extend  immunity  to  a  certain  issue,  a  special  act  of 
the  legislature  is  invoked. 

\l  Government  issues,  that  is  United  States  bonds, 
carry  exemption  always  and  everywhere,  but,  of  course, 
only  within  the  Federal  jurisdiction.  The  enjoyment 
of  this  privilege  is  not  alone  for  all  strictly  regular 
Government  issues  but  Congress  has  extended  it  to 
others  of  its  creation,  as  the  several  issues  for  the  Philip- 
pines, within  the  past  several  years,  and  the  Hawaiian 
territory  issue  of  1906,  due  1921,  giving  them  the 
status  of  United  States  Government  bonds,  in  this 
respect,  though  technically  they  are  otherwise.  No 
more  complete  statement  of  immunity  could  be  made 
than  for  bonds  issued  under  authority  of  Congress, 
when  on  the  instrument  is  written  that  they  are  exempt 
from  all  taxes  or  duties  of  the  United  States  and  from 
any  form  of  taxation  under  or  by  any  State,  local  or 
municipal  authority.  Once  beyond  the  borders  of  the 
country,  however,  they  may  be  subjected  to  existing 
taxation  laws  of  any  country. 

Exemption  of  State  obligations  takes  on  a  rather 
different  aspect.  Generally  speaking,  each  State  ex- 
tends to  its  own  issues  this  peculiar  benefit;  but,  as 
with  the  Federal  Government,  authority  so  to  do  ceases 
at  its  borders.  So  while  exemption  of  our  Government 
bonds  is  broad  and  practically  absolute — for  compara- 
tively few  are  held  outside  the  country — the  status  of 


Taxation  163 

State  issues  is  partial  exemption,  inasmuch  as  they 
often  drift  over  the  line  and  become  taxable. 

Except  through  liberality  of  the  native  State,  in 
some  instances  exempting  them  throughout  its  whole 
territory,  or  of  a  neighboring  State  likewise  disposed, 
municipal  bonds  have  a  still  narrower  sphere  in  which  * 
to  enjoy  it.  With  few  exceptions,  securities  of  the  most 
important  cities  of  a  State  are  tax  free  to  some  extent 
within  their  own  limits  for  all  purposes,  or  for  all  but 
State  purposes.  New  York  City,  for  example,  though 
with  issues  of  either  kind,  has  nearly  all  entirely  free. 

Counties  and  the  smaller  divisions  generally  are  less 
favored,  since  their  obligations,  on  the  whole,  are  com- 
paratively little  exempt.  Yet  some  county  bonds, 
along  with  city  bonds,  are  fully  exempt  within  their- 
home  State.  Notably  in  Pennsylvania  is  this  true,  • 
where  the  municipality  if  it  puts  out  its  issues  with  this 
stipulation,  itself  pays  a  tax  of  four  mills.  The  city 
of  Baltimore  carries  on  a  similar  practice;  it  pays  the 
State  tax  on  its  bonds  and  exempts  them  from  city 
taxation.  Moreover,  a  corporation  owning  Baltimore 
city  stock  is  exempt  to  the  extent  of  its  holdings  from 
city  and  State  taxation.  Consequently  these  securities 
are  much  sought  after  by  Maryland  corporations. 

Paying  the  tax  in  place  of  the  investor  is  a  method 
pursued  by  some  private  corporations  where  permitted. 
It  is,  of  course,  stated  in  the  bonds  of  most  companies 
that  "both  the  principal  and  interest  of  this  bond  are 
payable  without  deduction  for  any  tax  or  taxes  of  the 
United  States  or  any  State  or  Municipality  thereof 
which  the  company  may  be  required  to  pay,  or  to  retair 
therefrom,  under  any  present  or  future  law,"  a  stipula- 
tion which  must  not  be  confused  as  relating  to  the  taxa- 
tion under  discussion.  The  import  of  that  section  of  the 


1 64  Investment  Bonds 

contract  is  that  no  matter  what  taxation  of  company 
property  may  be  imposed,  nothing  will  be  taken  from 
the  interest  payments  or  withheld  at  maturity.  The 
bond,  nevertheless,  would  remain  subject  to  taxation 
in  hands  of  the  investor  were  it  not  for  the  arrangement 
between  State  and  corporation,  whereby  the  latter 
assumes  the  tax  to  relieve  the  investor,  much  in  the 
manner  pursued  by  Pennsylvania  counties  and  cities. 
Actually  such  securities  are  not  tax  free  in  distinc- 
tion from  the  bonds  of  some  railroads  which  are 
fully  exempt,  since  a  tax  is  paid,  though  not  by  the 
investor.  A  number  of  individual  States  in  the  north- 
western and  middle  Atlantic  groups  exempt  a  few 
comparatively  small  issues,  and  all  on  subsidiary  com- 
panies of  large  systems. 

Bonds  throughout  the  whole  country  escape  a 
second  form  of  taxation  such  as  is  now  imposed  by 
New  York  State  on  stock  certificates  in  addition  to  its 
levy  on  them  as  personal  property.  Every  stock 
certificate  transfer  involves  a  payment  of  two  cents 
on  par  value  of  $100  per  share.  During  the  Spanish 
war,  however,  in  1898,  bonds  were  under  a  tax  of  this 
nature  when  the  Government  required  five  cents  per 
face  value  of  $100,  but  immediately  the  necessity 
ceased,  it  was  withdrawn. 

The  effect  of  levying  a  tax  is  exactly  the  cause  for 
exemption  from  it;  reflex  action  of  taxation  is  in  the- 
market.  So  low  a  yield  as  is  common  with  most 
municipal  issues,  reduced  still  further  by  a  tax,  would 
make  their  possession  prohibitory  with  income  chiefly 
considered.  Even  so,  the  marked  effect  of  exemption 
is  in  their  distribution  more  than  price.  A  slightly 
advanced  price  may  be  attributed  to  exemption,  but 
the  clearly  discernible  tendency  is  to  remain  within 


Taxation  165 

the  boundaries  where  exempt;  in  other  words,  their 
localization  is  accomplished,  and  indirectly,  it  is  fair  to 
assume,  lending  to  the  civic  and  economic  betterment 
of  the  community.  At  the  time  of  year  when  returns 
are  made  as  a  basis  for  taxation,  there  is  always  the 
greatest  demand  for  n  on- taxable  securities — at  least 
this  is  true  of  New  York — and  for  this  reason  a  slight 
stimulus  is  given  to  their  price. 

As  to  foreign  securities  in  this  country;  they  fall 
within  the  common  category  of  personal  property  and 
are  no  more  heavily  burdened  than  our  own.  But  in 
European  countries,  outside  securities  are  more  or  less 
subject  to  discriminative  taxation.  In  France,  par- 
ticularly, strict  regulations  regarding  admission  of 
such  securities  are  in  force.  So  great  an  obstacle  to 
American  bonds  do  they  raise,  as  to  be  practically  pro- 
hibitive. Deduct  from  income  on  a  bond  stamp  tax  of 
6  cents  per  $100;  transfer  tax  of  \%  on  coupon  and  J% 
on  registered  issues,  with  income  tax  of  4%  on  the  inter- 
est, and  the  difficulties  may  be  appreciated.  The  French 
holder  of  the  bonds,  however,  if  taxes  are  not  paid, 
may  settle  with  the  Government  by  paying  2  %  on  the 
principal.  In  placing  foreign  securities  in  France,  the 
law  permits  two  methods  of  payment;  they  may  be 
placed  subject  to  an  annual  tax,  or  the  whole  tax  for 
the  life  of  the  securities  may  be  paid  in  a  lump  sum. 
In  the  case  of  the  $50,000,000  Pennsylvania  loan  of 
1906,  the  Paris  bankers  chose  the  latter  method  of 
meeting  the  taxes. 


CHAPTER  XVI. 

REFUNDING. 

RECORDS  of  the  New  York  Stock  Exchange  show 
that  of  the  bondslisted  on  that  Board,  a  large  percentage 
are  not  new  securities  in  the  strictest  sense,  but  con- 
tinuation of  debt  covered  by  one  or  more  previous 
issues.  This  is  fairly  indicative  of  the  extent  of  this 
practice  of  refunding.  It  is  not  done  solely  by  one  or 
two  classes  of  corporations,  but  rather  is  universally 
applied  to  the  necessities  and  policies  of  many. 

As  commonly  understood,  refunding  is  a  financial 
operation  by  which  any  corporation  changes  the  terms 
of  an  interest-bearing  debt.  In  public  finance,  the 
term  is  synonymous  with  conversion.  Moreover,  it  is 
interpreted  essentially  to  mean  continuation  of  a 
bonded  debt;  that  is,  the  replacement  of  one  or  more 
issues  by  another,  without  many  of  the  proceedings 
incident  to  one  entirely  new.  But  it  is  better  yet  to 
say  that  refunding  is  continuation  of  a  debt  in  any 
form,  so  long  as  that  debt  remains  within  the  category 
of  funded  obligations.  Even  this,  though  correct,  is 
too  narrow  for  the  purpose  of  the  moment.  A  broad 
application  of  the  principle  permits  mention  of  several 
other  phases  of  finance  wherein  the  debt  of  a  corporation 
is  carried  forward,  sometimes  in  like  form,  and  again 
in  a  different  form. 

166 


Refunding  167 

Strictly  and  financially  considered,  the  extension  of 
notes  by  new  ones  is  not  refunding,  though  the  prac- 
tical effect  is  the  same.  The  makers  of  collateral  notes, 
like  issuers  of  many  bonds,  rarely  make  provision  for 
the  payment  of  the  notes  at  maturity,  but  expect  to 
renew  them  at  the  then  prevailing  rate  of  interest. 

Not  only  are  notes  turned  into  other  notes  in  this 
manner  but  frequently  they  are  changed  into  bonds, 
thus  making  a  transition  from  floating  indebtedness  to1 
funded  obligation.  For  example,  both  the  Missouri 
Pacific  and  Chesapeake  &  Ohio  roads  in  1905  put  out 
bonds  for  this  very  purpose;  the  former  issued  a  large 
amount  which  was  not  used  at  all  for  refunding,  the 
greater  part  of  the  issue  going  to  fund  the  road's  ac- 
cumulated floating  debt.  The  latter  used  an  entire 
$4,000,000  in  the  redemption  of  its  notes.  The  opposite 
of  this  transaction  is  seen  in  the  issue  of  notes  to  take 
up  maturing  bonds.  It  sometimes  happens  that  an 
issue  matures  at  a  time  when  it  is  inadvisable  to  refund 
into  another  issue  in  the  face  of  an  adverse  market  or 
monetary  conditions.  In  this  emergency  notes  might 
be  issued  to  tide  over  the  period,  after  which  it  might 
be  advantageous  to  issue  a  long  term  debt. 

But  since  these  operations  are  comparatively  in- 
significant, they  serve  best  to  amplify  the  fact  that 
corporations  adopt  various  methods  to  reach  their 
end,  that  is,  the  continuation  of  their  debts  of  one  kind 
or  another.  Notes  for  notes  and  notes  for  bonds  are 
hardly  more  than  temporary  expedients.  Bonds  for 
notes  savors  of  permanency,  but  bonds  for  bonds  pre- 
ponderates and  is  the  most  frequently  occurring 
operation  of  renewal.  With  governments  refunding 
approaches  a  settled  policy.  Where  there  is  an  ex- 
pressed maturity,  the  debt  is  turned  over  and  over  by 


j68  Investment  Bonds 

this  method  rather  than  make  payment.  Particularly 
is  this  true  of  the  United  States.  We  make  our  debt 
practically  perpetual  by  constant  refunding;  many 
foreign  governments  expressly  state  theirs  to  be  so, 
hence  there  is  no  other  physical  evidence  of  the  debt 
than  a  mere  record  such  as  on  the  books  of  the  Bank  of 
England  for  British  Consols. 

As  for  the  necessity  for  refunding  in  our  own  country, 
tremendous  prosperity  and  high  financial  position 
indicates  full  ability  to  pay  off  its  debt.  No  doubt  it 
could  be  easily  retired,  but  it  has  been  the  consistent 
policy  of  the  Government  to  extend  each  issue  of 
bonds,  if  not  entirely,  in  part,  as  it  matures,  and  refund 
it  into  a  new  issue  at  a  lower  interest  rate.  From 
present  conditions  it  may  be  deduced  that  two  very 
potent  influences  lend  toward  perpetuating  this  in- 
debtedness. The  fact  that  the  Government  bonds  are 
security  for  National  Bank  notes  which  are  profitable 
to  the  issuing  banks  in  a  greater  or  less  degree,  is  no 
doubt  influential  in  this  direction.  Again  their  use 
as  security  for  public  deposits  strengthens  this  in- 
fluence. Required  by  the  law,  there  is  thus  created  a 
demand  for  the  bonds ;  and  while  this  necessity  remains, 
there  will  of  course  be  the  supply. 

But  with  those  governments  who  give  their  credi- 
tors no  physical  evidence  of  debt,  the  operation  con- 
sidered as  refunding,  is  little  else  than  a  book  change 
modifying  old  conditions.  Within  the  past  three  years 
several  large  governments  have  carried  on  extensive  re- 
funding plans.  In  1905,  the  Secretary  of  our  Treasury 
turned  into  2  per  cents,  more  than  $50,000,000  of  3  and  4 
per  cents,  under  a  special  law  of  1899  containing  refund- 
ing provisions,  wrhich  law  was  an  act  of  Congress  provid- 
ing that  all  the  bonds  of  the  United  States  bearing  3, 


Refunding  169 

4,  and  5  per  cent,  per  annum  and  maturing  in  1904, 
1907,  and  1908  might  be  refunded  into  bonds  not 
maturing  until  1930,  and  drawing  interest  at  the  rate 
of  only  2  per  cent.  The  Secretary  was  authorized  to 
exchange  the  outstanding  bonds  for  the  new  ones  upon 
terms  that  invited  the  transaction  on  the  part  of  the 
bondholders.  About  the  same  procedure  is  carried 
out  in  all  Treasury  refunding  operations.  A  circular 
is  issued  by  the  Secretary  naming  the  bonds  to  be 
taken  up,  also  the  ones  to  replace  them,  the  basis  of 
the  arrangement  and  necessary  directions  for  the 
physical  operation.  The  law  of  authorization  is  made 
a  part  of  this  circular.  About  a  month  before  the 
operation  is  concluded  another  short  circular  is  sent 
out,  notifying  all  holders  of  fundable  bonds  that  the 
privilege  will  be  suspended  after  a  certain  date. 

In  October  of  1906,  the  Argentine  Republic  furnished 
a  striking  example  of  refund,  changing  its  entire  in- 
ternal debt  bearing  six  per  cent,  to  one  of  five  per  cent, 
with  entire  success,  and  thereby  reducing  the  annual 
outlay  in  respect  to  the  internal  debt  by  several  mil- 
lions, practically  one  per  cent,  on  about  $65,000,000. 
The  bonus,  however,  that  the  Government  was  obliged 
to  pay  holders  was  great  enough  to  prevent  an  actual 
saving  for  the  first  three  years  of  the  new  bonds. 
Another  notable  financial  event  of  a  few  months  past 
was  when  Italy  likewise  adopted  this  course ;  when  the 
tremendous  total  of  nearly  two  billions  of  dollars  of 
four  and  five  per  cent,  rentes  were  reduced  to  three  and 
three  quarters  per  cent,  to  be  followed  later  by  three 
and  one  half  per  cent.  Out  of  this  huge  sum  less  than 
a  million  failed  to  be  refunded  through  the  owners' 
refusals.  Loaded  down  with  a  great  debt,  retrench- 
ment was  a  pressing  necessity,  and  as  appears  from  the 


170  Investment  Bonds 

figures  no  small  amount  of  interest  requirement  was 
saved  by  this  operation. 

Still  another  government  that  recently  carried  out 
what  was  practically  a  refunding  plan  is  Japan.  In 
March,  1905,  it  issued  $50,000,000  six  per  cent,  bonds; 
and  in  November  of  the  same  year  a  flotation  of  $250,- 
000,000  four  per  cents,  was  made  in  Paris,  Berlin, 
New  York,  and  London,  the  funds  being  used  partly 
for  the  redemption  of  the  six  per  cents,  and  partly  for 
redemption  of  some  internal  loans.  With  such  in- 
stances yet  fresh,  which  might  be  multiplied,  it  is  ap- 
parent that  public  debt  of  governments  is  in  a  constant 
flux. 

The  field  outside  of  public  finance  is,  of  course,  re- 
plete  with  evidence  of  the  tendency  to  refund  corporate 
debt.  As  in  many  other  ways,  the  railroads  are  pre- 
eminent in  perpetuating  their  obligations.  Indeed, 
many  corporations  when  making  an  issue  have  no 
intention  of  paying  the  debt  at  maturity,  but  fully 
expect  to  refund.  The  securities  of  such  lines  as  the 
New  York  Central,  Lake  Shore,  Michigan  Central, 
Pennsylvania  Railroad,  and  others  have  been  largely 
refunded  from  time  to  time.  So  pronounced  was  this 
practice  in  past  years  that  between  1894  and  1904  the 
railroads  refunded  many  millions  of  dollars  of  bonds; 
so  many  in  fact,  that  that  period  has  been  called  the 
"Refunding  Era"  exerting  a  great  influence  on  these, 
enterprises  in  general,  much  as  did  the  Consolidation 
Era  following  1880. 

Various  reasons  present  themselves  why  corporations 
adopt  this  policy;  in  some  cases  it  is  apparently  neces- 
sity, while  in  others  a  matter  of  election.  For  in- 
stance, should  a  government  provide  for  entire  payment 
of  its  debt,  increased  taxation  would  inevitably  follow, 


Refunding  171 

unless  some  needful  work  were  left  undone  or  expendi- 
tures curtailed.  A  debt  like  that  of  the  United  States 
is  not  burdensome,  hence  presents  no  necessity  for  its 
payment.  To  keep  the  debt  alive,  therefore,  is  to  do 
as  private  corporations  do,  who  otherwise  would  be 
under  the  necessity  of  collecting  revenues  largely  in 
excess  of  the  usual,  in  anticipation  of  maturing  of  a 
large  bonded  debt  some  years  hence.  By  them  a  struc- 
ture has  been  built  on  a  capitalization,  which  in  many 
cases  must  be  constantly  enlarged  to  meet  business 
conditions. 

Assuming  therefore,  no  more  than  a  fair  return  on 
capital,  it  is  obvious  that  pressure  must  fall  somewhere 
if  a  large  funded  debt  is  to  be  liquidated.  Of  course, 
an  entirely  new  bond  issue  might  be  applied  toward  this 
end,  but  that  would  not  be  practicable  every  time, 
hence  corporations  build  on  the  assumption  of  con- 
tinuing  the  debt  indefinitely,  and  this  to  be  done 
through  the  process  of  refund. 

But  undisturbed  continuity  of  use  of  funds  and 
setting  ahead  maturity  of  a  municipal  or  government  \ 
debt,  though  practically  perpetuating  it,  charges  future 
generations  with  a  care.  Through  some  untoward  cir- 
cumstance they  may  be  forced  to  meet  the  obligations 
at  maturity.  Potentially,  a  burden  as  this  is,  there  is 
altogether  some  justice  in  refunding  a  large  debt. 
With  private  enterprise,  some  companies  are  in  a 
period  of  adolescence  just  as  heavy  bond  issues  ma- 
ture. With  their  funds  the  business  has  been  devel- 
oped to  a  point  of  stability  and  earning  power,  so 
to  have  taken  gradually  from  current  revenues  suffi- 
cient amounts  to  liquidate  the  debt  would  have 
been  weakening.  At  the  moment  a  strong  financial 
policy  is  under  momentum  and  the  full  fruits  are  yet 


172  Investment  Bonds 

to  be  reaped.  Leaving  out  of  consideration  the  pos- 
sibility of  derangement  of  a  smoothly  working  financial 
scheme,  it  is  manifestly  fair  that  the  beneficiaries,  a 
generation  or  two  beyond,  should  succeed  to  the  debt 
as  well  as  the  larger  enjoyments  growing  out  of  it. 
As  well  does  this  argument  hold  in  municipal  affairs; 
property  that  has  appreciated  greatly  through  vast 
improvements  should  rightly  shoulder  the  burden  of 
taxation  to  meet  the  bonds. 

Some  incidental  effects  of  refunding  are  noticeable. 
Almost  invariably  in  railroad  finance,  a  refunding  mort- 
gage is  general  in  type  and  in  amount  greater  than  the 
sum  of  those  it  displaces.  It  is  customary  to  make 
the  total  large  because  of  several  functions  it  performs. 
Usually  the  iron  bound  limitations  of  previous  mort- 
gages are  outgrown ;  necessities  of  development  demand 
acquisition  of  fresh  capital.  A  new  mortgage,  say, 
second,  could  be  issued,  exactly  filling  the  need,  but 
this  is  not  generally  expedient  since  it  makes  the  debt 
more  heterogeneous  and  is  only  comparatively  tem- 
porary relief.  The  refunding  mortgage  is  comprehen- 
sive; it  does  more  than  provide  new  capital.  Through 
its  chief  function,  which  is  the  retirement  of  previous 
issues,  it  tends  to  unify  the  debt.  Occasionally  no 
old  bonds  are  refunded  at  the  moment,  yet  reservation 
is  made  for  their  maturity.  The  process  is  then  simply 
to  make  it  cover  a  large  issue,  sell  part  for  new  funds 
and  retire  other  issues  as  they,  come  due.  Occasionally 
refund  of  an  old  issue  is  prohibited,  when,  of  course, 
cash  from  reserved  bonds  is  used  to  settle  the  obliga- 
tion. Sometimes  investors  refuse  to  part  with  their 
holdings  till  the  end,  when  the  same  operation  must  be 
carried  out.  This  brings  out  the  fact  that  refunding, 
generally  speaking,  is  not  obligatory  on  the  holder ;  he 


Refunding  173 

may  get  new  bonds  or  money,  or,  if  his  bonds  are  not 
due,  may  retain  them  until  expiration.  This  latter, 
however,  is  obviously  an  alternative  only  when  refund 
of  an  issue  with  yet  some  years  to  run  is  attempted. 
Few  investors  take  this  position.  Practically  all  re- 
lease their  holdings  for  new  obligations  inasmuch  as 
such  favorable  terms  are  generally  made  as  to  be  readily 
acceptable.  They  vary  with  conditions;  bonus  may 
be  given  or  the  new  bonds  may  command  so  good  a 
market  as  to  compensate,  through  premium,  for  loss 
of  interest  on  old  ones. 

When  the  railroads  of  this  country  were  young,  they 
were  compelled  to  pay  high  interest  rates  on  their 
bonds.  Within  the  past  few  years  many  have  grown 
financially  strong  so  that  later  obligations  are  on  a  much 
lower  basis.  Many  have  rearranged  their  financial  set- 
ting, which  has  included  retirement  of  these  old  bonds 
through  refunding.  Such  replacement  usually  results 
in  saving  of  interest.  Take  the  case  of  the  $500,000 
Atlanta  &  Charlotte  Air  Line  bonds  which  were  ex- 
tended several  months  and  which  bore  seven  per  cent. ; 
the  contemplated  scheme  showed  a  saving  of  $127,500 
effected  by  refunding  into  four  per  cent,  issues.  Or 
again,  in  1900,  the  New  York  Central,  by  refunding  an 
issue  of  Harlem  Railroad  bonds,  saved  $420,000  a  year. 
Similarly,  municipalities  in  the  West,  within  the  past 
four  years  have  refunded  and  readjusted  their  interest 
rates  so  that  a  vast  amount  of  indebtedness  formerly  on 
a  six  and  seven  per  cent,  basis  will  not  be  drawing  more 
than  four  and  one  half  and  lower  from  now  on,  and  a 
great  annual  saving  is  effected. 

Generally  speaking,  where  it  is  an  underlying  lien  of 
old  bonds,  issued  at  high  rates,  there  is  a  saving  in  re- 
funding, but  many  of  the  new  and  modern  bonds  and 


174  Investment  Bonds 

large  issues  of  general  character  cannot  be  refunded 
and  save  anything.  The  high  rates  of  former  days  are 
past  and  many  issues  are  merely  refunded  into  the 
same  rate.  Even  of  the  old  bonds,  it  should  be  remem- 
bered that  if  they  are  refunded  in  advance  of  maturity, 
the  amount  of  saving  will  be  necessarily  somewhat 
reduced  since  some  allowance  has  to  be  made  to  the 
bondholder  to  cover  the  existing  premium. 


CHAPTER  XVII. 

EXCHANGE. 

IN  Wall  Street  parlance  little  distinction  is  made  be- 
tween various  operations  involving  what  is  considered 
an  exchange  of  securities.  The  terms  exchange,  con- 
version, and  refund  are  used  in  the  most  interchangeable 
manner  and  from  this  practice  might  be  regarded  as 
synonymous,  though  they  are  not.  It  is  true  that  refund- 
involves  an  actual  exchange  of  instruments,  but  that  is 
merely  incidental  to  such  an  operation ;  it  is  one  effect 
and  not  a  cause.  Likewise  refunding  means  that  a 
conversion  is  necessary,  but  still  that  is  not  properly 
expressive  of  the  operation.  Furthermore,  a  loose 
usage  of  the  term  conversion  leads  to  ambiguity;  to 
say  that  a  bond  is  convertible  might  mean  one  of 
several  things.  It  might  indicate  convertibility  into  its 
own  form  or  another  form  of  instrument;  it  might  be 
intended  to  convey  the  fact  that  the  security  may  be 
easily  turned  into  cash — readily  marketable — or  yet 
again  may  be  expressing  the  privilege  of  interchange- 
ability  accorded  to  holders  of  some  bonds;  that  is  to 
say,  the  privilege  of  obtaining  the  coupon  form  in  place 
of  the  registered  form  and  vice  versa,  at  pleasure.  Some 
private  corporations  and  a  few  municipalities  permit 
this  last  mentioned  operation.  Upon  surrender  of  either 
form,  the  other  may  be  obtained  and  the  process  re- 

175 


176  Investment  Bonds 

peated  to  secure  the  original  form.  Should  the  first  hold- 
ing have  been  in  coupon  form,  frequently,  upon  the 
resurrender,  the  same  numbers  as  those  originally  extin- 
guished are  given.  The  Federal  Government,  however, 
does  not  follow  the  practice  of  free  interchange ;  it  does 
give  the  registered  form  for  coupon  bonds,  but  the  in- 
convenience of  returning  a  bond  with  the  proper  cou- 
pons detached  has  deterred  it  from  the  other  operation. 

Refund,  again,  be  it  noted,  when  strictly  applied, 
relates  to  but  one  category  of  instruments — those 
representing  funded  debt.  Conversion  is  somewhat 
broader  in  its  application,  while  exchange  is  a  fully 
comprehensive  term.  To  put  it  differently,  exchange 
is  generic,  refund  is  specific.  Exchange  as  relating  to 
securities  should  be  broad  and  inclusive;  and  because 
of  this  it  may  mean  that  any  kind  of  instrument  is 
made  to  take  the  place  of  any  other.  The  exchange 
of  bonds  for  bonds,  in  the  majority  of  cases,  as  apart 
from  refund,  evidences  an  adjusting  process;  stock  for 
bonds  makes  a  funded  debt  out  of  what  was  a  capital 
liability  only;  giving  bonds  for  stock  is  purely  and 
simply  an  exchange,  and  cannot,  in  any  sense  of  the 
word,  be  a  refunding  operation.  Though  under  some 
circumstances  the  effects  of  refunding  and  a  pure  ex- 
change are  identical,  as,  for  instance,  in  their  tending 
to  unify  a  debt,  in  the  main,  the  motives  for  the  latter 
proceeding  are  fairly  distinct  from  those  of  the  other. 

Therefore  the  question  of  Exchange,  if  it  be  regarded 
comprehensively,  will  be  interpreted  as  meaning  an 
absolute  trade,  so  to  speak,  where  one  instrument  some- 
times displaces  another  and  at  other  times  does  not, 
whatever  be  the  financial  considerations  involved. 

The  exchange  of  bonds  for  bonds  has  already  been 
mentioned  as  largely  an  outgrowth  of  some  consolida- 


Exchange  177 

tion  scheme  or  of  reorganization  of  a  company  or  group 
of  companies.  So  far  as  the  great  industrial  consolida- 
tions, the  so-called  ''Trusts,"  were  concerned,  it  was 
generally  avoided  as  a  means.  New  bonds  were  issued 
and  exchanged  for  bonds  of  the  constitutent  companies 
only  when  these  latter  could  not  be  advantageously 
retired.  Enough  has  been  said  of  railroad  financing  to 
show  that  a  mutual  exchange  of  bonds  is  not  custom-  / 
arily  resorted  to  except,  perhaps,  in  reorganization. 
Then  there  is  considerable  exchange  of  securities.  > 
Those  bonds  covering  parts  of  the  line  which  have 
earned  exemption  from  scaling  for  their  securities 
are  generally  exchanged  for  new  bonds  at  equal  value. 
Various  arrangements  of  this  nature  grow  out  of 
the  circumstances.  Nevertheless,  there  are  occasions, 
even  in  prosperity,  when  railroads  adopt  this  method 
of  retiring  a  certain  bond  issue.  Holders  may  have 
the  privilege  of  exchange,  dollar  for  dollar,  of  an- 
other and  larger  issue,  expiring  at  the  same  or  a 
later  date.  Sometimes,  it  is  desirable  to  be  rid  of 
bonds  under  a  junior  mortgage;  so  by  making  them 
exchangeable  for  better  bonds  on  payment  of  an  as- 
sessment or  premium,  the  operation  may  be  success- 
fully carried  out.  A  comparatively  recent,  though 
obsolete  illustration  of  exchange  was  furnished  by  the 
Participating  issue  of  the  Oregon  Short  Line  Railroad 
when  this  wras  given  up  for  Collateral  Trust  bonds. 
In  rare  instances,  redeemable  bonds  may  be  exchanged 
for  others  at  the  time  of  call. 

Where  bonds  are  exchanged  for  stock,  however,  there 
is  a  broad  field.  Reorganization  and  consolidation,  of 
course,  furnish  many  ingenious  plans.  When  under 
stress  of  adversity,  it  is  imperative  that  fixed  charges 
be  reduced  somewhere.  The  best  way  to  accomplish 


173  Investment  Bonds 

this  is  to  eliminate  some  bonded  debt.  Hence,  it  is 
customary  to  exchange  for  some  kind  of  stock,  usually 
preferred,  the  bonds  on  parts  of  a  line  that  have 
not  paid.  Priority  of  claim  generally  affects  such 
negotiations;  and  senior  holders  effect  a  fairly  satis- 
factory exchange.  The  juniors,  however,  may  be 
compelled  to  pay  a  specified  amount  in  addition  to 
their  bonds  or  accept  an  equivalent  reduction  from 
their  new  securities. 

By  this  process,  a  fixed  charge  is  wiped  out  and  the 
/  substitution  of  a  dividend  that  is  contingent  on  earn- 
ings is  made.  So  successful  has  this  been  as  a  method 
of  financing  that  many  corporations  have  used  it. 
Within  the  last  fifteen  years  there  has  been  a  marked 
tendency  to  exchange  junior  bonds  into  preferred 
stock,  fully  $350,000,000  of  such  stock  having  been 
issued  for  old  bonds.  Considerable  of  this  has  been 
done  by  the  "Trusts."  The  constituent  corporations 
were  merged  by  as  conservative  use  of  bonds  as  possi- 
ble, and  wherever  possible,  preferred  stock  was  given 
in  exchange  for  their  funded  obligations.  One  distinc- 
tion should  be  noted  in  the  exchange  of  bonds  for  new 
stock  in  the  consolidation  process.  In  industrial  com- 
bines, the  new  stock  fills  the  place  of  the  bonds.  In 
some  railroad  combinations  both  securities  remain  in 
existence,  the  larger  company  obtaining  control  by 
the  stock  it  holds,  whereas  the  former  stockholder- 
becomes  a  creditor  of  the  system. 

Exchange  of  bonds  for  new  stock  as  in  reorganization 
and  consolidation  is  a  mere  accident,  but  as  a  privilege 
of  contract  in  convertible  bonds  it  has  become  a  promi- 
nent feature  in  many  large  capital  creations.  The  past 
two  or  three  years  have  shown  a  decided  tendency 
toward  financing  corporate  requirements  by  issues  of 


Exchange  179 

such  convertible  rather  than  straight  mortgage  bonds. 
As  a  type  of  bond  they  are  old ;  while  they  have  come 
into  prominence  lately,  they  were  quite  common  thirty 
or  more  years  ago.  Among  the  prominent  systems 
which  issued  them  at  that  time  were  the  St.  Paul, 
Burlington,  New  Haven,  Reading,  and  Erie.  However, 
between  that  time  and  three  or  four  years  ago,  prac- 
tically none  were  issued.  As  at  present  issued,  stock- 
holders in  the  company  are  often  given  "rights"  in 
subscription  to  these  bonds.  By  these  "rights"  they 
are  entitled  to  the  new  bonds  in  some  fixed  proportion 
to  their  holdings  of  stock  before  the  public  offering. 
This  proportionate  distribution  is  due  to  the  fact  that 
the  new  issue  of  bonds  is  not  likely  to  be  as  great  as  the 
outstanding  stocks. 

Conditions  surrounding  this  exchange,  or  conversion 
as  it  is  called,  of  the  bonds  into  stock  are  manifold. 
First  of  all,  the  stock  to  be  acquired  is  almost  invariably 
common  and  may  be  authorized  at  the  time  of  the  bond 
issue  or  some  time  later  when  the  exchange  becomes 
operative.  Indeed  many  corporations  issuing  con- 
vertible bonds  have  but  this  one  kind  of  stock  out- 
standing. How  early  or  far  removed  the  time  of 
exchange  may  be,  varies;  in  some  cases  it  is  after  two 
and  not  more  than  twelve  years  from  date  of  bonds, 
thus  giving  ten  years,  while  again,  as  with  the  Pennsyl- 
vania 3^5,  only  five  years  is  allowed;  or  the  terms  may 
permit  it  any  time  after  a  certain  date,  or  within  a 
certain  number  of  days  after  dividend  is  declared,  or 
upon  any  interest  date.  In  several  States,  corporations 
under  municipal  franchises  are  under  limitation  of  a 
specified  number  of  years  after  which  they  cannot 
carry  out  such  an  operation,  and  again  they  are  limited 
as  to  the  amount  of  new  stock  which  may  be  created 


180  Investment  Bonds 

for  these  bonds ;  Ohio  restricts  it  to  one  half  of  the  paid- 
up  stock.  The  basis  of  the  transaction  is  no  less  di- 
verse; and  a  few  typical  examples  may  be  cited,  such 
as  exchange  for  assenting  stock  at  200  per  cent. ;  into 
stock  at  $75  per  share;  into  stock  at  not  less  than  par; 
at  par  into  common  stock  at  $60  per  share;  one  bond 
for  ten  shares  of  stock;  one  bond  for  five  shares  of 
stock,  etc. 

Unless  there  be  some  design  in  giving  the  stock- 
holders an  opportunity  for  very  large  profits,  the  basis 
will  involve  an  estimated  market  value  of  the  stock 
at  conversion.  Should,  for  instance,  a  bond  be  ex- 
changeable for  stock  at  par  with  earnings  and  general 
conditions  indicating  a  prospective  market  quotation 
of  125  five  years  hence,  at  the  beginning  of  conversion, 
the  handsome  gain  to  the  stockholders  as  holders  of 
the  bonds  is  obvious.  Estimate  of  market  value  in 
this  manner  is  purely  optional  though  customarily 
done.  But  this  is  not  so  with  some  franchise  corpora- 
tions in  some  States,  for  by  statute,  there,  stock  taken 
in  lieu  of  bonds  must  not  be  valued  at  less  than  actual 
or  market  value.  The  opposite  of  this  operation  just 
described,  in  corporation  finance,  is  very  rare ;  that  is, 
the  exchange  of  old  stock  for  new  bonds  and  the  elimi- 
nation of  that  stock  from  capitalization.  Frequently  an 
exchange  is  made  for  purposes  of  control ;  one  company 
gives  its  bonds  in  a  predetermined  ratio  for  another's 
stock;  a  holding  company  is  formed  and  its  bonds  are 
exchanged  for  its  constituent  properties'  stock. 

Straight  exchange  of  but  one  kind  of  security  for 

•  one  other  is  not  always  the  rule.     Many  variations  are 

met,    especially    in    reorganization.     All    manner    of 

trades  are  made  in  which  one  or  two  kinds  of  stock 

with  one  or  two  types  of  bonds  may  be  received  for 


Exchange  181 

some  old  securities  of  either  kind  or  both.  Witness 
the  plan  of  an  industrial  corporation  carried  out  re- 
cently: it  provided  for  the  wiping  out  of  the  stock  of 
the  old  company  and  the  exchange  of  the  old  Income 
bonds,  some  seven  millions,  and  the  old  first  mortgage 
bonds,  approximately  three  millions,  for  new  stock 
and  new  bonds  as  follows:  the  new  issues  were  to  be 
5  per  cent.  First  mortgage  bonds,  5%  adjustment 
voting  bonds  and  capital  stock;  each  $1,000  first  mort- 
gage bond  of  the  old  company  to  receive  $500  in  new 
first  mortgage  bonds  and  $600  in  new  adjustment 
bonds ;  holders  of  old  first  mortgage  bonds  to  subscribe 
to  35%  of  their  holdings  in  new  first  mortgage  53  at 
75,  in  addition  to  what  they  receive  for  their  old  bonds; 
they  to  receive  as  bonus  with  bonds  subscribed  for 
$175  in  new  adjustment  bonds  and  $175  in  new  stock 
per  $1,000  of  old  bonds  held.  In  that  case  the  new 
first  mortgage  bonds  were  placed  at  a  valuation  of 
75,  new  adjustment  bonds  at  40  and  new  stock  at 
20,  so  that  for  $1,000  in  old  first  mortgage  bonds, 
the  holder  by  the  terms  of  the  exchange  paid  $262.50 
in  cash  and  received  securities  valued  at  $982.50. 

But,  of  course,  such  a  readjustment  of  finances  is  not 
necessarily  confined  to  the  time  when  a  corporation 
is  headed  for  bankruptcy.  Only  a  few  months  past 
the  Wabash  Railroad  carried  through  a  plan  whereby 
it  was  enabled  to  retire  some  $26,500,000  debenture 
bonds.  The  terms  agreed  upon  were  for  each  $1,000 
par  value  of  debenture  bonds,  Series  A,  $795,  par 
value,  of  new  bonds;  $580,  par  value,  in  preferred 
stock,  and  $580,  par  value,  in  common  stock,  of  the 
Railroad  Company.  For  each  $1,000,  par  value,  of 
debenture  bonds,  Series  B,  $720,  par  value,  in  new 
bonds;  $520,  par  value,  in  preferred  stock;  and  $520, 


1 82  Investment  Bonds 

par  value,  in  common  stock  of  the  Railroad  Company, 
scrip  to  be  issued  in  adjustment  of  fractional  amounts. 
Practical  examples  such  as  these  could  be  multiplied 
indefinitely,  yet  no  two  plans  are  identical;  every  one 
must  be  the  product  of  its  own  circumstances  and  the 
result  of  an  agreement  between  bondholders  and  the 
company. 

Generally  speaking,  there  is  mutual  advantage  in 
every  exchange  of  securities,  whether  the  initiative 
comes  from  the  corporation  or  bondholder:  both  gain 
by  the  operation,  if  not  at  the  moment,  in  later  years. 

The  redemption  of  a  corporation  by  reorganization 
is  its  gain.  If  through  this  process  it  shall  be  brought 
into  vigor  once  more,  some  permanent  loss  to  its 
bondholders  might  be  justified.  Though  the  exi- 
gencies of  such  cases  usually  demand  that  such  credi- 
tors scale  their  claims,  yet  the  exchange  is  often  made 
on  estimates  of  what  the  securities  will  be  worth  when 
the  full  force  and  effect  of  reorganization  is  realized. 
In  many  instances  the  future  has  so  appreciated  the 
new  holdings  that  eventually  the  original  debt  was 
realized.  Financial  history  is  not  without  its  record 
of  financial  and  considerable  loss  under  these  circum- 
stances, but  more  times  than  otherwise  just  such 
advantages  have  accrued  to  bondholders  who,  compro- 
mising their  claims,  have  lived  to  see  that  a  reasonable 
trade  was  the  wisest  course. 

Under  those  different  conditions  where  bonds  are 
given  for  bonds,  bonds  for  stock,  or  some  other  arrange- 
ment is  carried  out,  to  largely  obtain  corporate  control, 
the  security -holder,  being  under  no  constraint,  natur- 
ally expects  some  immediate  advantage  and  generally 
gets  it. 

But  in  the  scheme  of  exchange  of  convertible  bonds 


Exchange  183 

for  stock  of  the  same  company,  benefits  to  the  holders 
are  practically  deferred  for  a  while,  yet  the  issuing  cor- 
poration profits  both  at  the  moment  and  sometimes 
indirectly  when  its  creditor  reaps  his  profit.  By  the 
process  of  conversion,  for  instance,  the  Union  Pacific 
Railway  recently  lifted  its  $100,000,000  convertible 
bond  mortgage  of  1901,  the  satisfaction  of  which  re- 
leased some  850  miles  of  lines  from  all  bonded  indebt- 
edness. But  more  directly,  the  immediate  advantage  a 
corporation  gains  by  giving  this  privilege  of  exchange  is 
in  returns  from  sale  of  the  issue.  It  frequently  happens 
that  a  corporation  cannot  with  advantage  issue  stock 
as  a  means  of  obtaining  money  for  its  legitimate  needs ; 
neither  can  it  put  out  a  junior  lien  without  sacrificing 
something  in  price  and  paying  a  higher  interest  rate. 
Necessity,  however,  demands  a  pledge  of  property  or 
credit.  Such  being  the  case,  a  bond  with  this  feature 
of  future  exchange  ofttimes  exactly  fills  the  require- 
ments of  the  situation  with  justice  to  both  the  corpora- 
tion and  its  stockholders.  By  its  issue,  the  corporation 
is  enabled  to  borrow  on  a  satisfactory  basis  where 
otherwise  it  might  only  get  funds  at  an  exorbitant 
rate. 

From  the  standpoint  of  the  bondholder,  the  ad- 
vantages of  this  type  of  security  are  almost  obvious. 
Though  he  receives  a  comparatively  low  yield — no 
more  than  a  fair  return — his  attraction  lies  in  the  ^ 
future  profit  from  appreciation  in  the  price  of  the 
stock  which  he  may  receive  for  his  bonds.  This  privi- 
lege gives  an  element  of  favor  to  these  bonds  in  ^ 
view  of  the  possibilities  of  the  company  and  the  pro- 
spective rise  in  the  value  of  its  stocks.  The  tendency 
of  business  in  this  country  is  to  expand  and  the  value 
of  properties  that  are  well  managed  to  grow,  so  that 


184  Investment  Bonds 

this  conversion  feature  is  almost  sure,  through  stock 
appreciation,  to  be  of  value.  In  other  words,  the  in- 
vestor in  these  bonds  is  entitled  to  share  in  the  future 
profits  resulting  from  an  increase  and  growth  of  the 
business. 


CHAPTER  XVIII. 

BONDS  AS  COLLATERAL. 

A  GOOD  bond,  generally  speaking,  merits  its  position 
and  reputation  for  three  qualities  it  possesses — first, 
its  safety;  second,  its  profitableness,  and  third,  its  con- 
vertibility — this  last  taken  to  be  the  facility  with  which 
it  may  be  sold.  The  first  two,  safety  and  profit,  may 
be  regarded  as  inherent  qualities  and  constituting  a 
cause,  the  effect  of  which  is  the  third,  salability.  Yet 
the  relation  of  this  Trinity  of  virtues,  vital  as  it  is,  is 
no  more  essential  than  the  marketability  of  bonds  to 
their  usefulness  for  hypothecation  as  security.  Because 
of  their  very  character  as  a  financial  instrument,  they 
naturally  rank  in  high  esteem,  a  position  which  has 
made  possible  the  development  to  a  high  degree  of  the 
function  of  protecting  another  debt.  Mere  mention 
of  the  various  aspects  of  this  part  of  the  bond  business 
is  sufficient  to  indicate  its  breadth.  Precise  figures 
indicating  the  extent  to  which  bonds  serve  as  col-  * 
lateral  in  securing  debts  of  any  certain  class  are  prac- 
tically impossible  to  obtain  and,  save  for  a  single 
exception,  that  of  the  amount  of  bonds  under  bank 
note  circulation,  they  change  rapidly — from  day  to 
day  and  from  week  to  week.  By  limitation  of  law  not 
more  than  $9,000,000  of  national  bank  notes  may  be 
withdrawn  in  any  one  month,  consequently  the  ag- 

185 


1 86  Investment  Bonds 

gregate  amount  of  bank  currency  and  fluctuations  in 
this  amount  are  always  matters  of  public  information. 

Every  institution  that  loans  money  holds  in  its 
vaults  bonds  in  greater  or  less  amount,  as  security  for 
these  loans.  Among  these  lenders  the  national  banks 
are  foremost.  The  tremendous  figures  in  the  loan 
column  of  every  Saturday's  bank  statement  represent 
varying  but  always  large  amounts  of  bonds.  There 
are  the  large  banks  from  whom  other  banks  borrow, 
along  with  brokers  and  private  bankers  and  others  of 
all  degrees  of  standing  and  wealth,  on  loans  that  may 
be  for  "call,"  that  is,  immediately  returnable  at  the 
demand  of  the  lender;  for  "time,"  running  for  a  period 
of  one  or  more  months,  or  for  "demand,"  in  effect  an 
indefinite  time  loan  and  different  from  the  "call"  loan 
in  that  the  latter,  in  its  practical  application,  works  out 
to  be  a  matter  of  twenty-four  hours  only,  except  of 
course,  at  the  week-end  or  when  holidays  intervene. 
Supplementing  the  national  banks  are  private  bankers 
the  larger  and  stronger  of  whom  do  a  limited  business 
of  this  character.  Still  other  and  greater  factors  than 
these  in  the  loan  market  are  the  insurance  companies 
and  trust  companies,  both  of  whom  can  always  show 
substantial  items  of  loans  to  both  individuals  and 
corporations.  There  is  still  another  type  of  institu- 
tion to  consider — the  savings  banks — who  make  large 
loans  in  the  aggregate,  but  of  a  different  class,  never 
loaning  on  collateral  notwithstanding  the  excellence 
of  the  securities  that  could  be  presented.  All,  there- 
fore, except  the  savings  banks,  accept  bonds  as  col- 
lateral for  loans. 

A  different   situation   in   this   matter  of  collateral 

V     security,  by  deposit  of  bonds,  is  brought  about  by  the 

requirements  of  the  United  States  Government  in  its 


Bonds  as  Collateral  187 

dealings  with  the  national  banks.  It  too,  holds  bonds 
as  collateral  but  not  for  what  can  be  termed  loans, 
strictly  speaking.  As  is  well  known,  these  institutions 
are  depositaries  for  some  Government  money,  until 
recently  only  internal  revenue  receipts.  Now,  how- 
ever, under  the  provisions  of  the  so-called  Aldrich 
law,  the  Secretary  of  the  Treasury  has  authority  to 
deposit  customs  collections  in  the  national  banks  in 
precisely  the  same  way  as  internal  revenue  receipts. 
For  all  this  money,  sometimes  as  much  as  one  hundred 
and  fifty  millions  of  dollars,  the  Government  asks  se- 
curity in  the  form  of  bonds.  No  time  limit  is  set  for 
the  return  of  the  money  but  special  conditions  in  con- 
nection with  its  deposit  sometimes  develop.  During 
the  summer  of  1906,  to  assist  monetary  conditions, 
Secretary  Shaw  made  substantial  deposits  with  New 
York  banks  pending  the  receipt  of  gold  engaged  abroad. 
As  soon  as  the  metal  was  received  the  money  was  re- 
turned  and,  of  course,  all  such  deposits  were  secured 
by  satisfactory  collateral  in  the  form  of  bonds. 

Furthermore  the  use  of  bonds  as  collateral  is  neces- 
sitated by  the  bank-note  circulation  of  the  country, 
already  referred  to.  The  necessity  of  bond-secured 
circulation  is  deemed  by  some  authorities  as  an  evil  of 
our  currency.  However  that  may  be,  our  province  is 
to  consider  only  the  fact  that  bonds  are  the  security 
of  the  Government  in  its  permission  to  banks  to  issue 
circulating  notes. 

Until  the  action  of  Secretary  Shaw  in  breaking  with 
tradition  and  the  supposed  letter  of  the  law,  none  other 
than  Government  bonds  were  accepted  under  any 
condition.  He  construed  the  law  more  broadly,  to 
meet  the  exigencies  of  conditions,  and  for  public 
moneys  permitted  the  acceptance  of  some  State,  rail- 


i88  Investment  Bonds 

road  and  municipal  bonds  so  that  at  the  close  of  the 
year  1906  the  Treasury  held  close  to  $85,000,000  of 
these  miscellaneous  securities.  Now,  under  the  terms 
of  the  Aldrich  law,  there  is  no  restriction  on  the  classes 
/of  securities  that  will  be  available  as  security  for  de- 
posits beyond  the  provisions  that  the  security  shall 
be  satisfactory  and  that  on  or  before  the  first  day  of 
January  of  each  year,  the  Secretary  shall  publish  a 
list  of  securities  that  will  be  accepted  during  the  coming 
year.  It  is  assumed,  of  course,  future  Secretaries  will 
be  conservative  in  their  selections.  Nevertheless,  there 
had  been  no  deviation  from  the  rule  requiring  Govern- 
ment bonds  for  bank  notes  until  the  recent  Aldrich- 
Vreeland  act,  which  permits  the  use  of  some  municipal 
obligations  as  a  basis  for  emergency  circulation. 
Each  week  the  Treasury  puts  out  a  statement  of 
securities  held  in  trust  for  national  banks. 

A  further  use  is  found  for  bonds  as  collateral,  than 
securing  bank  loans,  assuring  the  safety  of  Government 
moneys  and  underlying  bank-note  circulation;  it  is 
their  utility  as  security  for  other  bonds  of  the  col- 
lateral trust  type,  to  which  end  they  have  been  largely 
used.  Accepting  these  four  general  applications  of 
the  principle  of  bond  security  as  practically  covering 
the  field,  there  are  yet  facts  to  be  considered  as  to  the 
practical  working  out  of  this  function. 

In  bank  loans  to  brokers,  bankers,  and  others,  per- 
haps the  most  variable  conditions  are  met.  In  the 
first  place,  a  great  many  loans  are  secured  by  mixed 
collateral,  which  may  be  bonds  and  stock ;  and  a  variety 
of  both  kinds.  Banks,  however,  often  do  have  all 
stock  and  all  bond  security.  Private  bankers  are  most 
apt  to  present  mixed  collateral,  that  is  bond  and  stock 
or  all  bond  security,  while  the  purely  stock  houses  are 


Bonds  as  Collateral  189 

generally  the  source  of  all  stock  collateral.  Some  banks 
will  accept  among  collateral  a  small  proportion  of  in- 
dustrial  securities,  of  such  companies  of  the  better 
class,  which,  by  their  records  have  established  a 
standing,  while  other  banks  will  take  practically  none. 
Collaterals,  mainly,  are  only  the  best  railroad  stocks 
and  the  best  bonds.  The  percentage  of  bonds  or  other 
securities  in  a  batch  of  collateral  is  anything  but  fixed ; 
it  is  the  effect  of  so  many  conditions  that  even  a 
generalization  is  impossible.  And  again,  from  day  to 
day,  substitutions  are  being  constantly  made. 

Banks  differ  radically  on  some  points,  as  for  instance 
on  the  percentage  of  market  value  at  which  they  shall 
accept  collateral.  A  rough  classification  of  the  secur- 
ities offered,  however,  is  possible;  experience  and  time 
have  fairly  well  defined  their  relative  position  from  the 
practical  viewpoint  of  the  banker.  This  much  may  be 
said  though,  of  the  policy  of  lenders  along  these  lines 
—it  involves  considerations  of  three  types;  financial, 
personal,  and,  what  might  be  called,  technical.  Under 
the  first  comes  the  general  state  of  the  security  and 
money  markets,  fundamentally;  under  the  second  an 
estimate  of  the  integrity  of  the  borrower  and  the  pro- 
tection he  would  afford  in  the  face  of  possible  loss. 
Into  this,  of  course,  enters  his  financial  standing. 
Toward  this  end,  each  bank  has  an  unwritten  classi- 
fication of  its  borrowers.  The  status  of  a  client  is 
reflected  in  a  measure  in  the  valuation  put  upon  secur- 
ities presented.  Large  banking  houses,  naturally, 
enjoy  a  superior  position  to  the  small  stockbroker. 

And  the  third  type  of  considerations  embraces 
matters  pertaining  to  the  bonds  themselves.  Intrinsic 
value,  as  we  may  call  it,  would,  of  course,  come  in  for 
scrutiny;  for  security  is  a  factor.  Then  again,  and 


190  Investment  Bonds 

perhaps  most  important,  is  its  marketability.  Since 
y-the  acceptance  of  a  bond,  or  in  fact  any  security,  hinges 
largely  upon  the  question — can  it  be  sold  if  necessary? 
— obviously  this  would  be  the  first.  What  it  will 
bring  in  the  open  market,  and  how  quickly,  are  vital. 
It  has  become  almost  axiomatic  that  the  broader  the 
market  for  an  issue,  the  more  readily  acceptable  is  it 
as  collateral.  It  is  consequently  to  the  interest  of  any 
corporation  to  secure  the  widest  possible  market  for 
its  securities,  preferably  an  international  market  with 
constant  arbitraging.  Stability  of  price  is  also  desir- 
able in  bonds  for  use  as  collateral.  Indeed  their  value, 
as  such,  in  many  cases  depends  upon  this.  High  and 
low  priced  issues,  and  those  that  fluctuate  widely  are 
less  in  favor  than  those  more  stable  and  close  to  par. 
Extreme  times  of  money  stringency  or  semi-panic 
materially  alter  these  general  conditions:  the  story  is 
that  in  the  financial  crisis  of  1893,  a  Chicago  packer 
is  quoted  as  saying  he  was  able  to  borrow  more  money 
with  his  pigs  as  collateral  security  than  on  his  Gov- 
ernment bonds. 

Now  with  bonds  underlying  collateral  trust  bonds 
and  notes,  many  of  the  same  questions  arise.  A  finan- 
cially strong  company  back  of  a  new  issue  naturally 
lends  favor  to  the  judgment  passed  upon  the  collateral ; 
a  somewhat  higher  valuation  is  likely  to  be  placed  on 
the  underlaid  securities  than  were  an  individual  to 
offer  them  for  a  loan.  Yet  bankers  are  cautious  withal ; 
before  floating  an  issue  each  underlying  security  is 
critically  analyzed  from  its  security  and  market  stand- 
points and  the  range  of  prices  noted  for  some  years 
and  an  average  obtained.  By  this  method  a  conserva- 
tive judgment  is  arrived  at  and  the  percentage  of 
market  value  that  is  safe  is  determined.  But  in  the 


Bonds  as  Collateral  191 

case  cf  Government  bonds  as  collateral  for  bank  notes 
there  is  less  variation  in  all  these  different  phases. 
All  such  are  taken  at  their  full  face  value,  and  well  they 
may  be,  for  all  stand  now  at  a  premium  in  the  market. 

When  the  Treasury  exercises  it  discretionary  powers 
as  to  the  acceptance  of  other  than  Government  issues 
to  cover  deposits,  it  generally  gives  them  only  a  per- 
centage of  their  market  value,  and  only  such  bonds  are 
accepted  as  are  lawfully  available  investments  for  the 
savings  banks  of  New  York  and  Massachusetts.  At 
least,  such  was  the  precedent  established  during  1906 
by  Secretary  Shaw,  when  these  bonds  were  accepted  at 
ninety  per  cent,  of  their  market  value.  Incidentally, 
the  action  of  a  Secretary  in  accepting  these  bonds  for 
such  purpose  is  a  tribute  to  their  standing  as  invest- 
ments. The  improvement  in  railroad  securities  in  this 
country  has  put  them  on  an  entirely  new  basis  from 
that  of  fifteen  or  twenty  years  ago  and  railroad 
bonds  now  constitute  better  collateral  for  loans  than 
ever  before. 

The  personal  element  that  enters  into  the  relations 
between  a  borrower  and  his  loaning  bank  are  absent 
with  the  Government  and  its  client,  so  to  speak,  the 
national  bank.  Be  the  bank  where  and  who  it  may, 
if  the  Secretary  elects  to  apportion  to  it  public  moneys, 
the  standardization  of  required  collateral  eliminates 
individual  considerations  of  any  kind,  so  necessary  in 
the  other  instance. 


CHAPTER  XIX. 

DEFAULT  AND  REPUDIATION. 

No  better  commentary  on  this  phase  of  our  sub- 
ject is  possible  than  the  laws  governing  investments 
of  savings  banks.  The  universal  provisions  for  their 
guidance  in  this  regard  are  full  of  significance.  Prac- 
tically every  State  of  the  Union  has  legislated  more  or 
less  specifically  along  this  line  and  from  the  evolution 
of  these  laws,  ever  toward  the  better,  has  come  the 
recognized  standard,  the  law  of  New  York  State.  In 
part  it  reads : 

Trustees  of  any  savings  bank  may  invest  in  the  stocks 
or  bonds  of  any  State  of  the  United  States  which  has  not 
/  within  ten  years  previous  to  making  such  investment 
defaulted  in  payment  of  any  part  of  either  principal  or 
interest  of  any  debt  authorized  by  the  Legislature  of  such 
State. 

In  the  stocks  and  bonds  of  any  incorporated  city  situated 
in  one  of  the  States  admitted  to  statehood  prior  to  Janu- 
ary, 1896  .  .  .  and  which  has  not  since  January  ist,  iSy'S, 
defaulted  for  more  than  ninety  days  in  the  payment  of  any 
part  either  of  principal  or  interest  of  any  bond,  note,  or 
other  evidence  of  indebtedness  or  effected  any  compromise 
with  the  holders  thereof. 

In  the  first  mortgage  bonds  of  any  railroad  corporation 
of  this  State  .  .  .  provided  that  at  no  time  within  five 
years  next  preceding  the  date  of  any  such  investment 

192 


UN 

of 


Default  and  Repudiation 

shall  such  railroad  corporation  .  .  .  have  failed  regu- 
larly and  punctually  to  pay  the  matured  principal  and 
interest  of  all  its  mortgage  indebtedness  and  in  addition 
thereto  ...  at  least  four  per  cent,  upon  all  its  out- 
standing capital  stock. 


Mark  the  difference.  Permission  is  here  given  to 
invest  in  the  obligations  of  both  public  and  private 
corporations.  But  with  the  former,  the  criterion  is  a 
matter  of  history — whether  default  or  repudiation  have 
occurred, — while  in  the  latter,  questions  of  financial 
position,  capitalization,  etc.  are  paramount.  That 
this  should  be  so  is  obvious.  To  ask  whether  a  railroad 
had  ever  defaulted  on  its  bonds,  though  answered 
negatively,  would  not  be  ground  to  assume  that  such 
action  is  never  likely  to  occur.  Such  a  test  would 
be  too  easy  to  meet.  Bending  all  energies  toward  this 
end  and  managed  so  as  to  provide  for  their  funded 
debt  regularly,  railroads  quite  generally  would  come 
within  the  scope  of  the  law.  To  them,  therefore,  more 
severe  conditions  must  be  applied  so  that  the  good 
and  better  may  be  weeded  out  and  none  other  left 
than  the  best.  The  dividend  requirement  accom- 
plishes this  perfectly.  More  than  a  few  roads  pay 
their  bond  interest  with  unfailing  punctuality  and 
ever  may,  yet  the  absence  of  dividends  on  all  outstand- 
ing capital  stock,  and  that  for  some  time  previous, 
disbars  them  from  the  favoritism  of  the  statutes. 
Necessity  impels  interest  payment,  but  substantial 
profits  is  the  only  warrant  for  dividends.  So  if  a 
railroad  has  taken  care  of  its  debts,  maintained  a  good 
physical  standard  for  the  property,  and  still  has  been 
able  to  disburse  to  its  stockholders  substantial  returns 
for  some  years,  the  inference  that  this  will  continue, 
13 


1 94  Investment  Bonds 

making  its  securities  safe,  is  fully  justified.  On  the 
other  hand,  the  fundamentally  different  conditions 
in  public  corporations  make  the  default  and  repudiation 
test  imperative.  In  the  one  financial  considerations 
hold  sway,  while  in  the  other  public  morality  is  called 
into  question. 

Default,  however,  on  bond  interest  may  occur  in  any 
corporation,  but  repudiation  is  confined  to  strictly  pub- 
lic corporations.  No  other  would  be  able  to  repudiate 
its  obligations  and  refuse  to  pay  interest  or  principal, 
since  means  of  redress  are  open  to  creditors  to  protect 
their  claims. 

Now  the  record  of  these  disagreeable  words  is  both 
bad  and  good.  Bad  in  the  history  of  some  States  and 
municipalities  in  the  United  States  until  about  thirty 
years  ago,  and  so  with  railroads  on  default  until  about 
the  year  1890,  when  the  period  of  their  reconstruc- 
tion was  well  under  way.  Happily,  since  then  com- 
paratively little  has  occurred. 

After  the  Civil  War,  in  the  days  of  the  so-called 
"  carpet-bag "  rule  in  the  Southern  States,  enormous 
amounts  of  bonds  were  issued  by  them,  their  cities 
and  municipalities,  which  later  on  were  repudiated  by 
wholesale,  so  that  there  are  perhaps  $400,000,000  of 
these  bonds  which  never  were  paid.  A  study  of  the 
conditions  surrounding  the  issues  reveals  almost  a 
full  justification  for  their  course  in  many  instances-, 
but  in  many  others  no  legal  or  moral  right  to  do  this 
could  be  shown.  In  the  midst  of  a  wave  of  general 
dishonor,  after  this  manner,  some  cases  of  splendid  iso- 
lation stood  out.  New  Orleans,  as  an  illustration  in 
point,  was  considered  a  victim  of  financial  mismanage- 
ment for  some  years  prior  to  1860,  loaded  down  with  a 
heavy  burden  of  legally  created  obligations  and  so  fully 


Default  and  Repudiation  195 

responsible.  Determined,  however,  to  place  honor  be- 
fore expediency,  her  people  set  about  a  programme  of 
self-denial  and  sacrifice  that  brought  them  through 
the  dangers  without  repudiation  of  a  single  dollar, 
without  scaling  a  single  bond  or  without  ever  passing 
an  interest  coupon. 

So  too  in  the  middle  West,  in  the  days  of  railroad- 
building,  millions  of  dollars  of  bonds  were  issued  by 
municipalities  throughout  that  region  in  assistance  of 
these  enterprises  and  afterward  repudiated.  Our  na- 
tional history,  be  it  said  with  pride,  is  without  a  blot 
in  this  regard.  The  mention  of  its  only  repudiation 
by  that  name  savors  now  of  humor,  when  we  remember 
what  great  loss  was  inflicted  by  State  and  municipal 
repudiation.  Nevertheless,  our  Government  may  truly 
be  indicted  on  this  count.  In  the  words  of  the  Con- 
gressional act  of  June  30,  1864,  " obligations  or  other 
security  of  the  United  States"  was  held  to  mean  all 
bonds,  certificates  of  indebtedness,  national  (bank) 
currency,  coupons,  United  States  Treasury  notes, 
stamps  and  other  representatives  of  value  of  whatever 
denomination  which  have  been  or  may  be  issued  under 
any  act  of  Congress;  yet  about  1887  the  Postmaster- 
General  ordered  that  all  stamps  issued  prior  to  1860 
would  not  be  received  for  postage  nor  redeemed,  and 
were  worthless.  This  is  the  only  known  instance  of 
repudiation  by  the  United  States  of  its  securities. 
However,  this  should  not  occasion  great  apprehension, 
for  an  unused  five-cent  stamp  of  1847  may  now  be 
sold  for  five  dollars. 

So  far  as  their  bond  obligations  are  considered,  no 
established  government  has  disavowed  any  of  its  debt   ; 
for  a  long  period.     More  or  less  of  this  has  been  fashion- 
able  among    Latin-American    countries,    particularly 


196  Investment  Bonds 

where  unstable  government  has  prevailed  and  changes 
of  regime  have  occurred  almost  in  company  with  the 
Equinox.  When  the  various  Central  and  South  Ameri- 
can countries  set  up  republican  forms  of  government 
they  quickly  issued  bonds,  nearly  every  issue  of  which 
has  not  been  without  a  checkered  career.  One  issue  in 
1890  bankrupted  a  great  London  firm  and  all  have  been 
at  times  regarded  as  worth  intrinsically  about  as  much 
as  the  discredited  securities  of  our  Southern  States. 
The  tap  root  of  this  evil  in  our  country,  as  far  as 
States  and  municipalities  were  concerned,  was  in  the 
chaotic,  or,  perhaps  better  said,  easy-going,  slipshod  and 
imperfect  methods  then  prevalent.  Political  chican- 
*  ery  likewise  in  no  small  measure  contributed  to  the 
result.  During  the  days  just  preceding  and  just  follow- 
ing the  war,  many  municipalities,  especially  in  some 
of  the  Western  States  and  territories  became  care- 
less and  extravagant  in  the  issue  of  bonds  for  all  sorts 
of  authorized  and  more  than  a  few  times  unauthorized 
purposes.  They  were  frequently  voted  with  little  or 
no  restriction  in  aid  of  all  sorts  of  railroad  schemes  and 
in  many  cases  for  railroads  never  built,  and  in  some 
cases  apparently  never  intended  to  be  built.  Instances 
might  be  given  where  bonds  were  issued  to  an  amount 
greater  than  the  assessed  value  of  all  taxable  property 
within  the  municipality.  It  was  not  strange  then  that 
those  who  came  a  little  while  after  should  seek  to  repudi- 
ate the  bonds  when  the  time  came  for  payment.  The 
greater  part  of  these  repudiated  bonds  of  Western  States 
were  those  issued  in  aid  of  railroads  or  for  some  purpose 
which  was  not  strictly  a  public  undertaking. 

But  default  on  the  interest  of  railroad,  manufactur- 
ing, or  public  utilities  corporation  bonds  is  a  different 
matter;  it  is  an  organic  disease  largely.  Here  the 


Default  and  Repudiation  197 

springs  of  earnings  may  be  drying  up  through  depres- 
sion in  business  or  by  the  blanching  sun  of  competition  ^ 
and  the  plant  withers.  In  a  word,  such  a  corporation 
may  be  too  heavily  capitalized,  so  that  the  lean  years 
find  it  unable  to  pay  its  interest  fully  and  promptly; 
it  may  be  under  the  strain  of  pressing  competition 
cutting  into  earnings,  or  may  be  the  victim  of  a  dry 
rot  of  mismanagement  unable  to  bring  out  of  a  good 
machine  its  full  capacities.  Unless  it  were  a  business 
that  succeeded  in  spite  of  itself  this  last  could  hardly 
fail  to  bring  it  to  the  brink  of  bankruptcy. 

It  is  a  fundamental  principle  of  law  that  for  every 
wrong  there  is  a  remedy.  There  is,  too,  a  sophism 
which  permits  an  exception  to  every  rule.  In  default 
and  repudiation  of  bonds  by  a  government  or  most 
states,  we  have  our  exception  to  our  rule  of  law.  Abso- 
lutely no  remedy  is  afforded  to  a  bondholder  if  a  govern- 
ment should  disclaim  any  of  its  obligations.  He  can 
sue  neither  it  nor  the  states.  The  individual  creditor 
is  helpless  except  in  rare  instances  where  he  may  be 
able  to  press  his  action  against  some  state  officials. 
But  several  states,  and  greatly  to  their  credit,  have 
provided  means  of  relief  against  themselves  in  cases  of 
repudiation.  Though  he  be  left  almost  or  quite  de- 
fenceless against  a  government  or  a  sovereign  state, 
which  is  constitutionally  forbidden  to  do  wrong,  he 
has  open  an  avenue  wherein  he  may  reasonably  hope 
to  obtain  reparation  for  his  wrongs  if  the  unpaid  or 
dishonored  bonds  be  of  a  municipality.  This  is  a  suit 
in  the  courts.  Quite  generally  such  proceedings  may 
be  instituted  and  at  least  some  satisfaction  gained. 
Indeed,  the  position  occupied  by  municipal  bonds  to- 
day may  be  attributed  largely  to  the  determined  stand 
of  the  United  States  Supreme  Court  in  past  years  in 


198  Investment  Bonds 

which  it  stood  out  against  repudiation  firmly  in  many 
cases  before  it,  where  this  course  was  attempted. 

Time  has  wrought  many  changes  for  the  better. 
To-day  an  ounce  of  prevention  is  regarded  as  worth  a 
full  pound  of  cure,  so  there  are  numerous  restrictions 
hedging  about  these  issues,  and  also  the  further  pre- 
cautions of  certification  of  legality  and  sometimes  of 
genuineness.  Irregularities  are  thereby  reduced  to 
a  minimum. 

The  aggrieved  bondholder  of  a  railroad  or  similar 
corporation  has  essentially  a  different  and  less  uncertain 
method  of  procedure.  Here  is  definitive  property  on 
which  he  generally  has  a  lien.  Although  figuring  in  the 
process,  the  courts  are  but  the  instrument  through 
which  he  wields  his  power.  Of  course,  there  are  gen- 
erally restrictive  provisions  against  its  exercise  until 
after  a  certain  time  has  elapsed.  A  corporation  may 
find  itself  in  temporarily  adverse  circumstances,  certain 
to  pass  away  in  a  short  while.  In  such  cases  it  would 
be  manifestly  injustice  to  precipitate  action  because 
of  an  unpaid  interest  coupon  and  so,  to  guard  against 
this  possibility,  there  is  generally  stipulated  something 
like  this — that  default  must  continue  for  one  year  or 
two  years ;  that  unless  default  is  made  on  the  first  mort- 
gage issue,  junior  holders  cannot  take  action.  But 
when  these  days  of  grace  have  expired,  they  are  free 
to  act.  The  story  of  what  follows  is  long,  as  is  some- 
times the  period  between  the  beginning  of  proceedings 
and  the  final  disposition  of  the  matter.  Briefly  stated, 
receivership  and  reorganization  follow  failure  to  pay 
interest  on  mortgage  bonds.  Foreclosure  and  judicial 
sale  are  the  nominal  rights  of  the  bondholders,  but 
seldom  does  it  come  to  this  extreme.  The  only  great 
railroad  ever  sold  under  foreclosure  was  the  Union 


Default  and  Repudiation  199 

Pacific,  a  few  years  past,  which  transaction,  after  all, 
was  much  of  a  formality. 

Not  alone  must  bondholders  weigh  the  effect  of 
foreclosure  on  their  securities,  but  the  possible  oppo- 
sition of  stockholders  to  such  a  plan,  for  by  the  terms 
of  some  mortgages  obstructive  tactics  may  be  indulged 
in  and  delay  an  adjudication  for  years.  Default, 
therefore,  means  practically  nothing  more  than  re- 
organization. On  the  vote  of  a  certain  percentage  of 
bondholders  the  trustee  may  act  for  them.  In  Massa- 
chusetts he  may  contract  for  operation  of  municipal 
franchise  corporations  after  •  conditions  of  the  trust 
deed  are  broken.  In  either  reorganization  or  fore- 
closure the  paramount  questions  of  priority  arise.  On 
the  supposition  that  default  on  a  junior  second  mort- 
gage has  brought  about  foreclosure,  let  us  see  what 
chance  the  bondholders  stand.  The  sum  thus  obtained 
would  be  applied  first  to  the  satisfaction  of  the  prin- 
cipal and  accrued  interest  of  the  first  mortgage  and 
any  balance  remaining  would  be  used  to  satisfy  the 
second  and  succeeding  liens,  and  after  all  this,  were 
anything  left,  it  would  be  distributed  to  the  stock- 
holders. But  the  thing  is  more  easily  said  than  done. 
With  a  possible  floating  debt,  a  swarm  of  obligations, 
secured  and  unsecured,  perhaps  liens  for  taxes,  labor, 
etc.,  and  then  two  or  three  kinds  of  stocks,  it  is  often 
necessary  that  all  creditors  present  their  claims  to  a 
court  and  for  it  to  establish  their  priority. 

The  relative  position  of  certain  issues  is  a  structural 
consideration;  it  depends  upon  how  the  financial 
structure  was  raised.  Generally  speaking,  the  specific 
liens,  or  prior  liens,  as  they  are  known,  such  as  divis- 
ional bonds,  rank  ahead  of  the  general  mortgages. 
Yet  there  are  first  mortgages,  in  fact  as  well  as  name, 


200  Investment  Bonds 

covering  the  entire  property.  After  these  general  liens 
come  such  issues  as  debenture,  income,  etc.  This 
position  in  the  general  scheme  of  things  is  of  vital 
importance  to  a  bondholder  in  reorganization ;  in  pro- 
portion to  the  strength  of  his  lien  is  he  able  to  make 
his  influence  felt  in  a  readjustment  of  affairs. 

One  of  the  first  effects  of  default  of  interest  on  many 
bonds  is  its  automatically  bringing  due  the  principal 
of  the  obligation.  This  enables  holders  to  bring  ac- 
tion. But  through  rearrangement  the  obligation  may 
be  continued  until  its  originally  stated  maturity.  If 
this  rearrangement  be  favorable,  the  bondholder  may 
emerge  with  little  loss,  but  generally  more  or  less  loss 
is  attendant  upon  the  proceedings.  Scaling  of  interest 
may  be  done  or  bondholders  may  waive  all  unpaid 
interest  upon  condition  of  prompt  payment  in  future. 
If  receivership  be  the  condition  its  baleful  influence 
is  felt  on  the  market  quotations  for  the  company's 
bonds  and  the  discredited  securities  are  poor  collateral 
on  which  to  borrow. 

In  the  realm  of  public  finance,  default  and  repudi- 
ation would  be  heavy  handicaps  to  bear — they  would 
mean  disrepute.  The  sins  of  years  ago  have  been 
fairly  forgiven,  but  a  repetition  would  mean  serious 
loss  of  position  in  the  community  of  states  or  nations. 
Such  heavy  loss  could  not  now  be  inflicted  on  creditors 
of  a  State  or  municipality  without  a  severe  punish- 
ment in  its  reflex  influence.  Thereafter  their  credit 
would  stand  on  a  very  low  plane  and  money  could  be 
borrowed  only  at  exorbitant  rates,  if  at  all.  Such  a 
fate  would  spell  stagnation  to  whomsoever  it  came, 
for  all  nations,  states,  and  smaller  divisions  have  con- 
stant need  of  fresh  funds  to  keep  pace  in  the  march 
of  progress. 


CHAPTER  XX. 

REORGANIZATION. 

WE  have  seen  that  inability  to  meet  fixed  charges,  K 
through  decreased  earnings,  increase  of  expenses,  or 
other  causes,  means  for  a  corporation  inevitable  bank- 
ruptcy; and  if  the  literal  legal  rights  of  the  creditors 
be  granted,  a  sale  of  the  property  under  foreclosure 
for  their  benefit,  unless  means  are  devised  to  avert 
this  calamity  and  put  the  corporation  upon  its  feet 
again.  Escape  from  this  utter  fate  of  bankruptcy  is 
generally  the  work  of  reorganization,  when  all  affairs 
are  put  upon  a  new  basis  and  life  is  begun  anew  with 
better  chances  of  weathering  the  storms.  It  is  not 
necessary,  however,  that  a  company  come  into  this 
sorry  plight  before  such  action  may  be  taken.  Re- 
organization is  by  no  means  always  to  save  from  total 
wreck,  but  often  a  rehabilitation  that  infuses  greater 
vigor  even  during  a  period  of  prosperity  and  the  full 
payment  of  all  debts.  Some  great  railroad  and  indus- 
trial consolidations  have  resulted  purely  from  a  rec- 
ognition of  the  advantages  to  be  gained  by  welding 
together,  by  means  of  reorganization,  a  number  of 
companies  while  fully  solvent,  although  it  is  true  the 
majority  have  arisen  out  of  the  precarious  and  weak- 
ened state  in  which  some  companies  have  found  them- 
selves. The  record  enumerating  the  long  list  of  railroad 

201 


202  Investment  Bonds 

reorganizations  of  the  early  nineties  bears  evidence 
to  prove  this,  and  a  number,  until  now,  have  passed 
through  two  such  ordeals  and  a  few  three  times,  among 
the  latter  being  the  Erie  Railroad.  At  one  time  more 
than  fifty  thousand  miles  of  railways  were  in  the  hands 
of  receivers,  and  between  1885  and  1905  such  prop- 
erties as  the  Baltimore  &  Ohio,  Atchison,  Topeka  & 
Santa  Fe,  Chesapeake  &  Ohio,  Erie  Railroad,  Phila- 
delphia &  Reading,  and  now  Southern  Railway  passed 
through  the  troublous  times  of  reorganization  largely 
without  foreclosure,  for,  to  repeat,  a  thoroughgoing 
readjustment  of  the  securities  of  a  road  or  system  in 
such  times  does  not  imply  a  sale  for  the  benefit  of 
creditors.  On  the  other  hand,  during  solvency  it  means 
a  more  advantageous  arrangement  of  securities  and 
the  strengthening  of  finances  generally,  and  when  the 
result  of  insolvency,  settlement  of  the  claims  of  all 
interested  on  an  equitable  and  satisfactory  basis  so 
that  the  property  may  be  released  from  court  proceed- 
ings and  again  managed  as  a  going  concern.  Even 
though  a  company  be  in  distress  it  may  yet  avoid 
receivership  and  foreclosure  if  co-operation  among  all 
security-holders  is  to  be  had,  before  intervention  of 
the  courts  and  a  receiver  be  a  necessity,  but  this  is 
seldom  possible.  Hence  with  the  institution  of  receiver- 
ship some  difficult  financial  problems  present  them- 
selves. Generally  speaking,  they  are  about  these: 
liquidation  of  the  floating  debt,  of  which  almost  every 
company  in  trouble  has  a  large  amount ;  rehabilitation 
of  the  property — that  is,  restoring  its  physical  con- 
dition generally ;  obtaining  cash  funds  for  this  purpose 
together  with  immediate  operation  and,  further,  mak- 
ing provision  for  future  needs.  Involved  in  all  this 
is  the  monumental  task  of  reducing  fixed  charges  to 


Reorganization  203 

a  point  no  longer  endangering  solvency  and  yet  har- 
monizing the  different  interests  involved,  a  task  re- 
quiring the  highest  type  of  financial  knowledge  and 
judgment. 

This  is  best  accomplished  by  the  immediate  forma- 
tion of  "protective"  committees,  as  they  are  known,  tx 
representing  each  class  of  security  or  perhaps  one 
committee  representing  all.  Such  might  be  appointed 
by  the  receiver  or  the  directors  to  formulate  a  plan 
to  which  security-holders  would  be  invited  to  assent. 
It  could,  however,  be  self -constituted,  composed  of 
some  of  the  larger  holders  scattered  over  a  number  of 
States,  or,  as  is  generally  the  case,  a  group  of  repre- 
sentative financiers  whose  plan  would  be  apt  to  be 
just  in  every  particular  and  meet  with  success,  receiv- 
ing the  indorsement  of  all.  To  this  end  bondholders 
are  invited  by  public  notice  to  deposit  their  securities 
with  some  trust  company,  as  trustee,  and  when  a  ma- 
jority have  been  so  lodged  an  agreement  is  prepared 
and  presented  for  approval.  The  opposite  course  may 
be  followed — formulating  plans  of  reorganization  and 
under  them  asking  the  approval  of  the  bondholders. 
But  the  variations  in  this  procedure  are  many  and, 
of  course,  entirely  governed  by  the  conditions  pre- 
vailing at  the  moment.  Should  a  large  majority 
accept  the  proposed  arrangement,  the  remaining  bond- 
holders are  generally  compelled  to  abide  by  their  action. 
Any  contest  to  demonstrate  the  contrary  would  meet 
with  scant  consideration  in  the  courts,  for  it  would  most 
likely  be  held  that  with  a  majority  assent  the  plan 
becomes  operative.  Suppose  this  were  not  so;  a  hag- 
gling minority  would  disrupt  what  would  generally  be 
a  fair  adjustment,  and  to  insist  upon  legal  rights  rather 
than  evince  a  regard  for  the  commercial  necessities  / 


204  Investment  Bonds 

of  the  case  would  in  the  end  bring  no  more  than 
the  due  proportion  of  the  value  obtained,  which  in 
all  probability  would  be  less  than  under  the  plan  of 
reorganization. 

The  activities  of  this  committee  are  manifold  and 
its  scope  broad.  To  determine  the  position  of  each 
security  and  amicably  adjust  the  rights  of  many  con- 
flicting claims  is  no  small  labor.  First  of  all  some 
fundamental  considerations  must  be  remembered,  as 
for  instance  that  the  unquestionably  good  bonds  on 
the  property  should  be  so  recognized  and  a  nicety  of 
discrimination  made  between  the  really  good  and  those 
that  are  not.  In  the  main,  a  plan  of  reorganization 
involves  an  exchange  of  securities  so  that  the  burden 
of  loss,  where  necessary,  shall  be  equitably  distributed. 
How  shall  this  be  determined?  Before  any  decision 
can  be  reached  an  analytical  examination  of  the  prop- 
erty must  be  made  to  put  a  proper  valuation  upon 
every  constituent  part  and  its  relative  value  to  the 
whole.  Subsidiary  companies  of  all  kinds,  leased  and 
branch  lines,  must  be  thoroughly  sifted  to  ascertain  if 
the  basis  of  division  of  earnings  between  the  parent 
company  and  the  smaller  company  has  been  just,  for 
largely  on  this  showing  depends  the  strength  or  weak- 
ness of  some  issues.  Nor  is  it  possible  to  arrive  at 
an  intelligent  conclusion  without  going  back  for  some 
years.  To  this  end,  the  statistics  of  previous  years  are 
used.  In  other  words,  accountants  would  seek  to 
determine  the  earning  power  behind  each  issue  of 
bonds  and  whether  interest  has  been  fully  earned  for 
that  period.  All  this  done,  the  committee  has  the 
groundwork  for  its  new  structure. 

In  every  reorganization  more  or  less  immediate  loss 
falls  upon  the  majority  of  security-holders.  Possibly, 


Reorganization  205 

absolutely  prior  liens  may  come  through  with  none  at 
all,  but  it  is  only  those  most  firmly  intrenched,  and 
which  demonstrate  beyond  a  perad venture  that  they 
have  contributed  to  net  earnings  their  full  share,  that 
fare  so  well.  In  so  far  as  they  have  earned  their  in- 
terest is  their  lien  retained.  But  losses  are  not  borne 
by  the  bondholders  or  creditors  alone;  the  owners  or 
stockholders  stand  to  bear  their  part  of  the  burden. 
Their  opportunity  is  immediately  at  hand.  As  we 
have  said,  there  must  be  considerable  cash  raised  for 
current  expenses  and  to  give  the  company  its  first 
lift  out  of  difficulty.  Ordinarily  the  first  resort  is  an 
assessment  of  stockholders.  It  is  no  more  than  fair 
that  they  should  raise  a  good  part  of  the  cash  if  they 
wish  to  retain  their  interest  in  the  property.  This  they 
are  generally  willing  to  do.  Yet  the  conditions  imposed 
by  the  reorganization  plan  of  bondholders  have  some- 
times been  so  manifestly  unfair  that  shareholders  have 
had  recourse  to  appointment  of  committees  to  repre- 
sent them,  and  even  in  a  few  instances  presentation 
of  their  case  before  the  courts.  Under  other  circum- 
stances unanimity  among  all  classes  of  security -holders 
is  readily  forthcoming,  but  in  extreme  cases  an  unac- 
ceptable plan  is  just  enough  to  compel  organization 
among  the  disaffected  interests  in  self-defence.  Though 
stockholders'  claims,  being  residuary,  are  generally 
weak  and  little  felt  in  reorganization  proceedings,  their 
voice  is  heard,  at  least  in  concurrence. 

When  reasonable  in  amount,  payment  of  such  as- 
sessments is  obviously  the  part  of  wisdom.  Let  the 
stockholders  refuse  to  pay  and  the  bondholders  may 
take  the  property,  destroying  the  value  of  their  stock 
and  making  the  loss  absolute.  They  would  be  doubly 
unwise  in  such  a  course,  since  the  payment  of  assess- 


2o6  Investment  Bonds 

ment  may  be  carried  along  some  months,  giving  ample 
opportunity  to  procure  the  money.  Furthermore  it 
would  generally  be  shortsightedness.  As  we  shall 
presently  see,  in  the  exchange  of  securities  are  given 
new  securities  that  reviving  business  and  a  rehabilita- 
ted condition  are  sure  to  enhance,  perhaps  to  the  point 
of  actual  profit. 

For  the  bondholders  the  degree  of  immediate  loss 
is  determined  by  the  position  of  their  security.  Upon 
the  stronger  may  fall  the  necessity  of  accepting  a 

\  reduction  in  principal,  although  continuing  at  the  same 
rate  of  interest;  a  reduction  of  interest;  or,  if  affairs 
are  badly  demoralized,  some  of  either.  In  a  few  in- 
stances, junior  bondholders  have  been  asked  to  pay 
an  assessment,  for  the  stockholders  could  not  be  relied 
upon  to  furnish  the  full  amount.  Unjust  as  this  is, 
there  may  be  no  alternative  if  they  would  retain  as 
good  a  hold  on  the  property  as  at  present.  The  Atchi- 
son,  Topeka  &  Santa  Fe  reorganization  committee 
in  1895  Put  it  bluntly  to  these  junior  creditors  when 
they  said  in  effect — out  of  $14,000,000  cash  to  be 
raised,  $10,000,000  is  all  we  believe  the  stockholders 
will  stand;  it  behooves  you  therefore  to  stand  the 
other  $4,000,000  for  your  own  protection. 

Every  successful  reorganization  means — and  in  fact 
it  is  fundamental — that  there  be  a  rearrangement  of 
securities.  Old  securities  which  existed  before  the  cor- 
poration became  insolvent  disappear  and  new  one's 

v  take  their  place.  One  bond  issue  may  be  resolved 
into  two,  or  vice  versa.  Frequently  the  former  stock 
is  replaced  by  other  issues.  As  a  general  rule  there 
will  be  fewer  kinds  under  the  new  plan  than  before, 
and  in  apportioning  the  losses  and  making  satisfactory 
trades  lies  the  complexity  of  the  whole  matter.  Im-  / 


Reorganization  207 

mediate  loss  are  the  words  heretofore  used  in  alluding 
to  this  phase  of  reorganization.  This  is  meant  to 
indicate  that  it  is  possible  for  none  to  suffer  ultimately, 
by  the  expediency  of  exchange  of  old  securities  for 
new  ones  of  immediate  value,  with  others  whose  value 
will  be  developed  by  the  future.  The  underlying 
principle  is  that  security-holders,  who  under  the  stress 
of  necessity,  must  sacrifice  something,  should  have 
opportunity  of  regaining  that  much.  Hence  the 
practice  of  giving  new  bonds  with  no  obligatory  in- 
terest, and  new  shares  in  the  nature  of  compensation. 
To  the  bondholders  asked  to  sacrifice  principal  or 
interest  was  given  an  amount  of  income  bonds  in  some 
cases  and  in  others  preferred  stock.  Non-cumulative 
preferred  stock  was  better  than  income  bonds,  since 
with  the  latter,  though  no  interest  need  be  paid,  the 
principal  would  in  a  few  years  become  due.  Likewise 
stockholders,  for  their  assessments,  often  received  in- 
come bonds  or  preferred  stock. 

On  first  thought,  this  practice  of  giving  new  secur- 
ities to  represent  their  concessions  would  seem  to 
defeat  a  primary  object  of  reorganization,  and  that  is, 
the  reduction  of  capitalization.  So  far  as  par  value 
is  considered  this  is  true,  but  it  does  not  prevent  the 
desideratum  of  reduced  fixed  charges.  If  all  capital- 
ization in  excess  of  an  amount  where  fixed  charges  will 
be  well  within  minimum  net  earnings,  is  represented 
by  no  stronger  claims  than  income  bonds  and  pre- 
ferred stock,  little  danger  may  be  apprehended  for 
some  time.  So  in  the  general  exchange  of  securities 
it  has  happened  that,  while  the  bonded  debt  repre- 
senting fixed  charges  has  been  pared,  the  total  has  been 
increased.  New  mortgage  bonds  might  have  been 
sold,  necessarily  at  a  low  price,  to  raise  the  cash  neces- 


2o8  Investment  Bonds 

sary,  but  this  would  have  increased  fixed  charges. 
Better  far  was  it  to  assess  everybody  possible  and  give 
them  a  prospect  in  form  of  new  paper  such  as  above. 
This  was  not  always  done;  the  disturbed  securities 
in  other  cases  were  reduced  or  converted  into  claims 
of  inferior  lien  and  all  without  any  increase  of  capital- 
ization. Of  the  two  plans  the  latter  would  seem  most 
judicious,  for,  should  future  trouble  overtake  the 
'  company,  a  greatly  increased  capitalization  would  only 
tend  to  increase  the  difficulty  of  a  favorable  solution. 

Even  though  the  outstanding  capital  be  not  increased 
immediately,  provision  is  made  that  will  eventually 
bring  about  this  result.  In  the  substantial  amounts 
of  authorized  bonds  we  find  this.  The  necessary 
betterments  of  future  years  are  anticipated  by  this 
action.  Many  large  issues  of  mortgage  bonds  are  in 
part  reserved  for  this  purpose  and  their  issue  limited 
to  a  certain  amount  each  year,  and  then  often  only 
with  the  consent  of  a  majority  of  bondholders,  majority 
of  stockholders,  or  even  both. 

Thus  among  the  effects  of  reorganization  are  increase 
or  decrease  of  capitalization  and  at  least  a  provision 
for  the  former.  Whether  capital  is  shrunk  or  enlarged 
there  is  always  a  simplification  of  securities  effected. 
A  dozen  issues  may  be  fused  into  two  and  a  lot  of 
miscellaneous  bonds  consolidated  into  some  compre- 
hensible form.  The  advantages  to  be  derived  are 
obvious;  opportunities  for  development  are  afforded 
quite  impossible  under  a  mass  of  scattered  issues. 
Yet  another  effect  is  readjustment  of  relations  with 
subsidiary  companies,  leased  lines,  etc.  In  the  changes 
of  business  fortunes,  contracts  may  have  become 
burdensome  and  traffic  and  other  agreements  proved 
unprofitable.  Now  is  the  time  for  modification  of  all 


Reorganization  209 

that  are  onerous.  .Rental  of  leased  lines  may  be  re- 
duced and  agreements  with  independent  or  connecting 
lines  for  interchange  of  traffic,  division  of  earnings 
therefrom,  use  of  cars,  etc.,  may  be  continued  under 
new  terms.  Absolute  repudiation  of  such  contracts 
is  impossible  without  the  formation  of  a  new  company 
and,  as  an  antecedent,  foreclosure.  But  this  would  pro- 
duce a  complication  still  more  difficult  to  handle  than 
others.  The  old  company  was  probably  incorporated 
years  ago  under  a  very  favorable  charter  and  now, 
should  a  new  company  be  organized,  some  privileges 
could  not  be  obtained  in  a  new  charter.  Desirability, 
therefore,  of  maintaining  an  old  charter  and  preserving 
the  old  company  is  a  potent  factor  in  determining  the 
attitude  toward  old  contracts.  If  the  old  charter  is 
of  decided  value,  the  ad visability  of  reorganizing 
without  foreclosure  and  making  the  best  terms  pos- 
sible with  security-holders  of  subsidiary  companies  is 
patent. 

A  noteworthy  illustration  of  ingenuity  used  to  ac- 
complish an  equitable  adjustment  of  a  crippled  com- 
pany's affairs  is  seen  in  the  case  of  a  street  railway 
in  the  West.  The  property  was  sold  to  satisfy  the 
first  mortgage  bonds.  Its  real  purchasers  were  the 
bondholders'  committee.  This  committee  caused  the 
title  to  be  taken  in  the  name  of  another  railway,  a 
corporation  of  nominal  capitalization  and  officered  by 
the  committee.  (Foreclosure  and  sale,  in  any  instance, 
is  but  a  convenient  way  of  transferring  title.)  This 
company  is  now  operating  the  property  and  will  con- 
tinue to  do  so  until  the  committee  feels  sure  as  to 
what  the  result  under  normal  conditions  should  be. 
When  that  point  is  reached  a  reorganization  plan 
will  be  prepared  and  made  effective. 


210  Investment  Bonds 

The  experiences  of  railways  in  the  United  States 
furnish  almost  wholly  the  material  in  consideration  of 
this  important  subject  and  from  the  principles  evolved, 
together  with  the  natural  development,  has  come  a 
great  and  strong  financial  interest. 


CHAPTER  XXI. 

VOTING  POWER. 

SAVE  for  the  classic  exception  to  a  rule,  there  would 
be  no  occasion  to  consider  this  peculiar  phase  of  bond 
issue.  Contrary  to  a  basic  principle  of  corporation 
finance,  in  that  a  creditor  is  in  no  sense  entitled  to  a 
voice  in  administrative  affairs,  there  are  bonds  carrying 
with  them  voting  power.  It  is  absolutely  at  variance 
with  correct  practice  and  indeed  no  company  in  a 
healthy  financial  condition,  with  marketable  credit 
and  prosperous  business,  ever  resorts  to  this.  For 
resort  it  is — an  expedient  by  the  company,  and  a 
privilege  rather  than  a  right  for  the  bondholder. 
Only  in  the.  extremities  of  financial  difficulty  such 
as  a  time  of  reorganization  is  it  ever  granted.  The 
granting  of  voting  power  to  bondholders  is  so  radical 
a  departure  from  accepted  methods  that  naturally 
not  many  instances  are  found.  Indeed,  less  than  a 
dozen  issues  now  extant  carry  this  privilege.  There 
is  no  well  defined  course  followed  in  this,  but  the  greater 
number  of  issues  so  treated  are  income  bonds.  In 
one  or  two  instances,  first  and  second  incomes  were 
issued  but  only  firsts  were  permitted  to  vote.  Other 
than  these,  a  few  mortgage  bonds  are  accorded  this 
privilege  besides  a  few  scattered  issues  of  debentures. 

Among  the  last  named  and  most  prominent  in  this 

211 


212  Investment  Bonds 

respect  were  two  series  of  outstanding  debentures 
of  the  Wabash  Railroad.  These  series,  denominated 
"A"  and  "B,"  were  entitled  to  one  vote  at  the  stock- 
holders' meetings  for  every  $100  of  principal  and 
to  nominate  one  half  of  highest  even  number  of 
the  board.  For  an  illustration  of  others  so  en- 
titled we  turn  to  the  Erie  Railroad.  Out  of  the 
last  reorganization,  in  1895,  came  $35,000,000  Prior 
Lien  bonds  and  $140,000,000  general  lien,  both  of 
which  were  given  voting  power  in  the  proportion  of 
ten  votes  for  every  $1,000.  Possibly  the  Atlanta 
&  Charlotte  first  mortgage  ys,  mentioned  elsewhere, 
and  which  fell  due  in  1907,  were  the  only  example 
of  a  bond  so  well  secured  and  at  the  same  time  able 
to  exercise  this  office.  All  these  show  that  one  vote 
for  every  $100  of  principal  has  generally  been  the 
representation  given.  In  this  it  corresponds  to  the 
general  practice  of  stock  voting — one  vote  for  every 
share  of  par  value  of  $100,  although  it  -is  not  im- 
perative that  this  be  the  ratio.  At  the  option  of  the 
company  or  of  those  conducting  the  reorganization, 
one  vote  for  every  $500  could  be  given  or  one  vote 
for  each  complete  bond,  but  the  disproportion  be- 
tween the  stockholders'  and  bondholders'  power  in 
such  an  arrangement  might  militate  against  a  success- 
ful outcome  of  this  part  of  the  plan. 

Where  voting  power  has  been  given  to  bonds, 
the  greater  part  of  these  have  been  unsecured  as  to 
interest.  Income  issues  are,  of  course,  secured  as  to 
principal,  but  in  all  cases,  whatever  the  type  of  bond, 
secured  or  unsecured,  the  underlying  idea  has  been 
to  vest  in  the  holder  ability  to  protect  his  interest. 
In  reorganisation,  as  stated,  income  bonds  are  given, 
to  \yhich  shall  accrue  interest  "if  earned,"  Just  here 


Voting  Power  213 

is  the  point.  With  so  flimsy  a  claim  on  the  earnings 
of  the  company  and  without  any  power,  the  bond- 
holder has  no  means  of  compelling  directors  to  pay 
him  interest,  even  when  apparently  earned.  Given 
a  position  of  equality  with  stockholders,  there  is 
some  hope  that  by  his  voice  in  affairs  he  may  come 
to  enjoy  a  portion  of  profits.  In  the  reorganization 
of  the  American  Rope  &  Twine  Co.,  the  so-called 
''Cordage  Trust,"  the  income  bonds  were  given  a 
position  of  commanding  influence  above  the  stock 
for  a  limited  time.  They  may  elect  a  majority  of  the 
board  of  directors  until  interest  has  been  paid  on 
all  bonds  for  two  consecutive  years.  After  that  is 
accomplished,  the  majority  vote  goes  to  the  stock. 

The  fact  that  many  income  issues  of  early  reor- 
ganizations never  received  an  interest  payment  ac- 
counts largely  for  the  privilege  of  voting  given  the 
later  ones.  But  where  the  issue  is  a  mortgage  bond, 
with  obligatory  interest,  while  the  intention  is  still 
to  give  the  bondholder  opportunity  to  protect  his 
interests,  it  works  out  somewhat  differently.  His  claim, 
to  be  sure,  is  definite,  but  if  he  is  unable  to  be  felt  in 
the  policies  of  the  company,  it  may  be  again  endangered 
by  unwise  financial  management.  Here  then  his  vote 
gives  him  power  in  matters  such  as  affect  the  increase 
of  debt,  etc.  Thus  it  has  been  good  policy  to  extend 
the  privilege  of  vote  to  some  bonds,  for,  conscious  of 
a  status  in  the  management  of  affairs,  the  bondholders' 
fears  have  been  allayed.  The  position  of  senior  mort- 
gage bondholders  with  a  vote  is  especially  good; 
having  a  strong  claim,  a  lien  back  of  it,  and  behind  all 
the  ability  to  help  guide  affairs  to  their  welfare,  the 
position  is  enviable  among  securities.  But  the  income 
bondholder  without  vote  stands  in  somewhat  the 


214  Investment  Bonds 

same  relation  to  his  company  as  the  common  stock- 
holder, aside  from  the  voting  power.  The  voting 
income  bondholders  may  exert  some  influence  on 
the  policy  of  the  company,  yet  alike  with  all  stock- 
holders they  are  partakers  of  profits  alone.  Exactly 
so  is  the  case  of  voting  debentures. 

Withal  that  these  bonds  have  been  vouchsafed 
this  measure  of  self-protection  and  privilege,  few 
avail  themselves  of  it.  Except  for  the  Wabash  de- 
bentures of  recent  months,  pronounced  activity  in 
company  affairs  has  never  been  noticeable,  partly 
for  the  reason  that  it  has  been  unnecessary  and  partly 
because  of  the  inconvenience  attendant  on  the  oper- 
ation. To  vote  bonds  requires  their  registration  as 
to  principal,  at  least.  Similar  to  the  record  of  stock- 
holders that  is  necessary  to  be  kept,  is  one  of  voting 
bondholders.  Unless  an  imperative  need  for  action 
exists  the  bondholder  is  prone  to  neglect  his  pre- 
rogative. 

In  a  greater  or  less  degree,  voting  power  in  a  bond 
is  an  element  for  good  in  its  market  standing.  Such 
inferior  obligations  as  they  usually  are  need  the  stim- 
ulus of  some  special  conditions  to  give  them  any  kind 
of  standing.  Hence,  potential  with  trouble  for  the 
management  in  the  event  of  grossly  unfair  treatment, 
there  is  ever  likely  to  be  a  show  of  justice,  and  this 
is  in  turn  reflected  in  their  quotation. 


CHAPTER  XXII. 

MUNICIPAL  BONDS. 

PUBLIC  debt  is  ever  a  subject  of  more  than  ordinary 
interest.  Its  vital  importance  in  the  structure  of  our 
public  economy  makes  it  worthy  of  a  close  study 
alike  to  the  banker  and  student.  In  this  country  it 
comes  under  three  heads,  each  distinct  and  practically 
independent  of  the  others.  There  is  the  Federal 
Government  contracting  and  administering  its  own 
debt;  then  the  several  States  and  Territories  with 
their  individual  obligations,  and  again  the  lesser  di- 
visions, counties,  towns,  cities,  etc.  The  history  and 
development  of  these  three  phases  individually  could 
well  constitute  a  complete  treatise,  and  would  be 
highly  instructive  as  illustrating  certain  tendencies 
connected  with  public  indebtedness.  While  not 
attempting  a  discussion  of  these  broad  questions,  a 
few  general  facts  pertaining  to  the  last-mentioned 
phase  of  public  debt  should  be  considered  here. 

Viewing  public  debt  in  its  most  general  aspects, 
a  comparison  of  figures  is  inevitable.  Indeed  in  this 
manner  the  relative  position  of  the  immense  volume 
of  municipal  bonds  outstanding  is  best  appreciated. 
Reverting  again  to  an  earlier  chapter  it  may  be  noted 
that  of  the  grand  total  of  all  bonds  fully  twenty  per 
cent.,  and  likely  more,  are  of  this  class,  which  in  ap- 

215 


216  Investment  Bonds 

proximate  figures  represents  more  than  $2,000,000,000 
of  these  securities.  Over  against  this  something 
over  $900,000,000  of  interest-bearing  debt  of  the 
Federal  Government  must  be  put,  and  a  further  com- 
parison with  State  indebtedness  presents  still  stronger 
contrast.  The  bond  obligations  of  all  our  States  and 
Territories  make  a  total  well  under  $275,000,000.  It 
should  be  remembered,  however,  that  many  munici- 
palities carry  floating  debt  of  one  kind  or  another 
and  many  others  have  varying  amounts  of  obligations 
of  a  temporary  nature.  Though  contributing  to  totals, 
these  latter  are  sufficiently  unimportant  to  be  passed 
over  as  a  factor  in  municipal  debt,  aggregating  but 
a  few  millions  of  dollars. 

Comparison  of  totals  may  be  profitably  followed 
by  some  analysis  of  them.  The  stupendous  figures 
for  municipal  bonds  lead  naturally  to  a  consideration 
of  their  source.  It  might  be  supposed  that  the  bond- 
issuing  policy  of  a  State  is  a  fair  index  to  the  action 
of  its  municipalities  in  this  regard.  Were  it  not  for 
the  important  part  that  constitutional  restrictions 
play  in  preventing  States  from  accumulating  a  heavy 
bonded  debt,  this  might  afford  a  basis  for  comparison. 
Yet  there  is  something  to  be  learned  by  noting  the 
debts  of  individual  States  and  of  the  States  by  groups. 
Extreme  conservatism  reigns  in  a  number  of  States, 
since  they  show  no  bonded  debt  whatever,  but  this 
does  not  always  hold  when  their  municipal  obligations 
are  considered.  New  Jersey  and  Ohio  are  cases  in 
point. 

It  is,  of  course,  practically  impossible  for  developing 
communities  to  be  without  debt,  perhaps  like  .their 
States.  The  exercise  of  their  functions  for  improve- 
ment is  essentially  local,  hence  the  debt  becomes  local. 


Municipal  Bonds  217 

Contiguity  of  these  minor  divisions  in  the  building  of 
roads,  for  example,  makes  for  good  highways  through- 
out the  State,  and  unless  such  a  work  is  a  special 
project  the  State  is  relieved  of  the  necessity  of  its  pros- 
ecution. It  follows  then  that  the  States  of  greatest 
development  are  likely  to  show  the  greatest  municipal 
debt;  and  so  it  is  with  few  exceptions.  All  our  large 
cities  have  great  piles  of  debt  to  take  care  of:  New 
York  with  over  half  a  billion  dollars;  Boston,  a  hun- 
dred million  or  over;  Chicago,  twenty-five  million — 
and  so  on.  The  thickly  settled  communities  show 
the  largest  amount  of  absolute  debt,  the  greatest  per 
capita,  and  the  highest  ratio  of  increase.  New  munic- 
ipal needs  arising  out  of  the  growth  in  population  and 
business  have  made  large  municipal  expenditures 
natural  and  inevitable.  New  cities  have  grown  up, 
old  ones  have  enlarged,  and  demands  for  improvements 
have  multiplied  greatly. 

Comparisons  of  sections  of  the  country  under  State 
groups  bears  this  out.  The  Financial  Chronicle  adopts 
a  geographical  division  for  this  purpose  that  serves 
well  and  is  therefore  used  here.  In  the  North 
Atlantic  States,  covering  New  England,  with  New 
York,  New  Jersey,  and  Pennsylvania,  we  find  an  ap- 
proximate total  of  $1,000,000,000;  in  the  South 
Atlantic  division,  Delaware,  the  Virginias,  Carolinas, 
Georgia  and  Florida,  $165,000,000;  North  Central 
group,  comprising  the  States  which  have  enjoyed 
wonderful  development  in  the  central  West,  namely, 
Ohio,  Indiana,  Illinois,  Michigan,  Wisconsin,  Minnesota, 
Iowa,  Missouri,  Nebraska,  Kansas,  and  the  Dakotas, 
$550,000,000 ;  South  Central  di  vision,  Kentucky,  Tennes- 
see, Alabama,  Mississippi,  Louisiana,  Texas,  Arkansas, 
and  Oklahoma,  $200,000,000;  and  the  Western  division 


218  Investment  Bonds 

Montana,  Wyoming,  Colorado,  New  Mexico,  Arizona, 
Nevada,  Utah,  Idaho,  Washington,  Oregon,  California, 
about  $140,000,000;  which,  in  comparison  with  the 
figures  for  the  year  1890 — North  Atlantic  $470,000,000, 
South  Atlantic  $166,000,000,  Northern  Central  $320,- 
000,000,  Southern  Central  $135,000,000,  Western  Divi- 
sion $45,000,000 — emphasizes  the  point  that  the  debt 
has  grown  fast  mainly  in  the  sections  where  it  might 
be  expected,  yet  in  some  degree  throughout  the  whole 
United  States.  Again  the  figures  show  that  the  greater 
part  of  the  bond  issues  is  still  supplied  by  the  North 
Atlantic  tier  of  States  as  above  laid  out.  In  1906  out 
of  about  $202,000,000  of  bonds  placed  $107,000,000 
came  from  that  group.  The  Northern  Central  Divi- 
sion stands  next  in  importance,  being  accountable 
for  about  $55,000,000  of  the  total.  The  other  parts 
of  the  country  furnished  relatively  small  contributions 
and  the  South  Atlantic  group  especially  is  credited 
with  a  very  small  amount — only  $6,642,880. 

A  still  finer  analysis  of  the  question  of  expansion  of 
municipal  debt  and  its  comparison  with  State  and 
Government  debt  reveals  these  facts:  that  national 
debt,  except  for  the  period  during  the  Spanish  War, 
has  been  almost  constantly  declining  since  the  Civil 
War;  that  State  and  Territorial  debt  has  decreased 
consistently  until  recently,  when  some  extension  began 
due  principally  to  Massachusetts  and  two  or  three 
other  States ;  that  county  debt  throughout  the  country 
has  gradually  increased,  but  comparatively  slowly,  and 
that  the  debt  of  cities,  villages,  townships,  and  school 
districts  has  increased  most  markedly  in  a  course  of 
expansion  that  has  been  very  rapid. 

It  has  been  observed  that  municipal  bonds,  though 
constituting  almost  entirely  municipal  indebtedness, 


Municipal  Bonds  219 

are  not  yet  the  gross  debt.  Gross  debt  must  neces- 
sarily include  all  floating  obligations  and  those  tem- 
porary in  nature — of  course  everything.  Neither  is 
the  total  of  bonds  issued  by  some  municipalities  the 
net  debt.  Upon  this  question  of  net  debt,  in  many 
cases,  hinges  the  amount  of  bonds  that  may  be  put 
out.  All  municipalities  are  limited  to  a  percentage 
of  their  assessed  valuation;  hence  we  find  statutory 
pro  visions  something  like  this:  No  bonds  can  be 
issued  which  shall  increase  the  net  debt  to  an  amount 
exceeding  five  per  cent,  of  the  value  of  the  taxable 
property  therein  as  appraised  for  assessment  of  taxes. 
In  explanation  of  the  above  this  is  said :  To  ascertain 
net  debt,  all  debts  must  be  included  except  the  fol- 
lowing, which  must  be  deducted:  water  debt,  "cash 
and  other  means"  in  treasury,  and  sinking  funds  ap- 
plicable to  payment  of  debt  so  included.  Or  again : 
"Net  indebtedness  as  used  above  shall  mean  the 
indebtedness  of  a  county,  city,  towTi  or  district,  omit- 
ting debts  created  for  supplying  the  inhabitants  with 
water  and  other  debts  exempted  from  the  operation 
of  the  law  limiting  their  indebtedness,  and  deducting 
the  amount  of  the  sinking  funds  available  for  the 
payment  of  the  indebtedness  included.'* 

By  such  interpretation,  in  some  States  many  muni- 
cipal bonds  may  be  issued  even  after  the  maximum 
amount  as  fixed  by  the  law  is  reached,  but  they  are 
generally  for  some  profit-making  enterprise  where  the 
earnings  may  be  applied  to  the  payment  of  interest 
and  redemption  of  the  bonds.  The  illustration  given 
names  a  low  percentage,  but  in  other  States — New 
York  for  one,  where  it  is  ten  per  cent. — higher  figures 
prevail.  Where  the  law  is  liberal  in  its  exclusions 
from  net  debt,  the  percentage  is  generally  low,  and 


220  Investment  Bonds 

vice  versa.  In  some  cases  the  debt  may  be  a  definite 
percentage  and  no  more.  Another  circumstance  that 
enables  cities  in  New  York  State  to  issue  bonds  far 
beyond  the  actual  ten  per  cent,  limit  is  found  in  the 
position  of  bonds  held  in  the  sinking  funds.  They  are 
held  not  to  be  a  part  of  the  city  debt  within  the  mean- 
ing of  the  provision  of  the  constitution  limiting  it,  since 
they  are  considered  as  a  debt  that  the  city  cannot  be 
called  upon  to  pay,  though  the  payment  of  its  inter- 
est into  the  sinking  fund  may  be  compulsory.  Inci- 
dentally, a  different  stand  is  taken  by  the  Interstate 
Commerce  Commission  in  its  requirements  of  railroads. 
In  their  computation  of  debt,  bonds  belonging  to 
sinking  funds  must  be  classed  as  outstanding  and 
brought  into  the  figures. 

In  view  of  these  variations  of  conditions  with  local- 
ity, net  municipal  debt  has  not  everywhere  the  same 
interpretation  nor  does  it  represent  all  bonds  issued. 
Property  valuation,  therefore,  is  no  assured  restraint 
on  bond  issuing  ability  although  it  is  the  best  working 
basis.  It  should  be  noted  that  municipal  debt  is  in 
a  ratio  to  the  assessed  valuation  and  not  the  actual. 
Here  again  is  an  element  affecting  the  total  amounts. 
Throughout  the  country,  assessed  valuation  varies 
considerably:  Eastern  and  New  England  States  show 
a  high  valuation,  averaging  seventy-five  to  eighty 
per  cent. ;  Western  Middle  at  sixty  per  cent. ;  Western, 
forty  per  cent. ;  Pacific,  fifty-five  per  cent. ;  Southern, 
seventy  per  cent.  The  date  of  valuation  also  varies 
from  once  a  year  to  once  in  several  years. 

Municipal  bonded  indebtedness  everywhere  is  estab- 
lished and  carried  after  certain  general  principles, 
tending,  of  course,  toward  uniformity  in  methods. 
Beginning  with  the  smaller  divisions  of  government, 


Municipal  Bonds  221 

each  has  its  officers  empowered  to  act  when  the  bonds 
are  authorized.  The  burden  in  each  instance  is  on 
the  particular  municipality  and  that  alone,  so  that 
county  bond  issues  in  California  and  Maine  have  no 
peculiar  distinctions.  There  are,  however,  a  few  un- 
common situations  existing  in  this  country  affecting 
municipal  debt.  One  is  in  Massachusetts.  The  city 
of  Boston  is  the  central  point  of  a  "Metropolitan" 
district,  including  about  forty  towns  and  cities  within 
a  distance  of  twelve  miles.  All  of  these  are  liable  for 
three  kinds  of  debt:  Metropolitan,  Municipal,  and 
State  "direct."  The  unusual  point  of  the  situation  is 
that  many  Metropolitan  obligations  are  issued  "in 
the  name  and  behalf  of  the  Commonwealth  and  under 
its  seal,"  and  are  "deemed  a  pledge  of  the  faith  and 
credit  of  the  Commonwealth,"  thus  creating  a  State 
debt ;  but  the  State  is  empowered  through  the  Supreme 
Judicial  Court  to  collect  from  the  municipality  directly 
involved,  such  apportioned  annual  contributions  as 
will  pay  that  debt.  Hence  these  municipal  debts  are 
to  the  State  nominal  or  contingent,  making  State  debt 
thereby  fall  in  to  two  classes,  Direct  and  Nominal  or  Con- 
tingent ;  for  the  former  the  Commonwealth  is  directly 
and  entirely  responsible  and  for  the  latter  it  has  loaned 
its  credit  to  sundry  cities  and  towns.  The  city  of 
Washington  in  the  District  of  Columbia  furnishes 
another  illustration  of  diversity.  Here  the  functions 
for  providing  for  municipal  debt  are  assumed  by  the 
Federal  Government.  The  District  has  a  funded  debt 
provided  for  by  sinking  fund,  the  charge  of  which  is 
vested  in  the  Treasurer  of  the  United  States.  Congress 
annually  appropriates  money  for  interest  and  for 
final  redemption.  Nowhere  else  does  a  similar  con- 
dition exist  since  here  the  debt  is  consolidated  into 


222  Investment  Bonds 

one  fund,  and  no  such  items  as  water,  sewer,  and 
improvement  bonds  are  found  but  all  is  known  as 
the  " Bonded  debt  of  the  District  of  Columbia." 

Municipal  needs  are  of  a  similar  character  through- 
out the  land;  the  requirements  for  schools,  court- 
houses, bridges,  roads,  etc.,  are  common  to  all  and  the 
necessities,  of  course,  multiply  in  ratio  with  size  and 
growth.  If  a  brief  classification  of  the  large  majority 
of  such  bonds  were  necessary,  they  could  all  be 
included  by  the  word — improvement.  So  far  as 
municipal  bonds  go,  few  are  distinctively  peculiar 
to  any  locality.  In  some  sections  of  the  country  private 
enterprise  produces  special  types  such  as  irrigation 
bonds,  in  the  arid  lands  of  the  southwest  and  in  low 
lying  and  wet  portions  of  some  States,  drainage  or 
ditch  bonds,  with  the  reclaimed  land  as  security,  but 
seldom  do  internal  government  divisions  put  out 
obligations  so  peculiarly  distinguished.  About  the 
only  ones  so  marked  are  the  levee  bonds  of  the  westerly 
Southern  states,  Louisiana,  Arkansas,  and  one  or  two 
others.  Numerous  places  in  these  States  must  be 
shielded  from  inroads  of  the  rivers,  which  lays  upon 
the  communities  the  necessity  of  self -protection. 
Here  and  there  among  cities  we  find  odd  types,  the 
creation  of  special  circumstances.  For  instance,  rapid 
transit  bonds,  to  build  underground  railways;  de- 
ficiency and  revenue  bonds,  to  tide  over  a  temporary 
need  for  funds  or  the  anticipation  of  tax  collection 
out  of  whose  proceeds  they  will  be  redeemed;  judg- 
ment bonds,  to  provide  funds  to  meet  judgments  of 
the  courts,  and  a  few  others  equally  uncommon. 
New  York  City  has  some  " General  Fund"  bonds, 
issued  for  the  purpose  of  releasing  the  surplus  reve- 
nues of  the  sinking  fund  of  the  old  city  of  New  York 


Municipal  Bonds  223 

(amounting  to  upwards  of  $8,000,000  yearly)  and 
to  allow  the  money  to  be  applied  to  the  reduction  of 
taxation;  Yonkers,  N.  Y.,  has  "Redemption"  bonds, 
issued  to  purchase  lands  bid  in  by  the  city  at  sales 
of  property  for  non-payment  of  taxes  and  assessments 
and  the  bonds  are  to  be  paid  out  of  money  received 
for  redemption  of  lands  so  purchased;  New  Orleans 
has  an  old  issue  called  "Premium"  bonds,  par  value 
$20,  issued  in  1875,  payable  1925  at  5  per  cent.,  in- 
terest not  paid  annually  but  when  the  bond  is  paid. 
By  a  species  of  lottery  scheme  a  certain  amount  of 
bonds  are  redeemed  each  year  at  which  time  money 
prizes  from  $20  up  to  $5000  are  distributed  by  lot 
amongst  the  holders  of  the  redeemed  bonds.  By  this 
method  the  investment  may  be  terminated  at  any 
time,  when  the  holder  will  receive  principal,  interest 
since  date  of  issue  and  perhaps  a  prize  of  substantial 
value. 1  Such  financing  is,  of  course,  a  relic  of  days 
long  since  past. 

One  other  type  of  municipal  issue  should  be  men- 
tioned— that  is  assessment  bonds.  Issued  to  improve 
certain  streets,  build  special  sewers,  etc.,  or  do  some 
such  work,  the  abutting  property  is  subjected  to  special 
assessments  to  provide  interest  and  finally  extinguish 
the  debt  under  the  assumption  that  it,  most  of  all, 
if  not  alone,  enjoys  the  benefits.  For  this  reason, 
too,  the  safety  of  these  bonds  rests  on  that  property. 
The  justice  of  this  position  is  questioned  by  some 
able  men.  That  a  fine  street  materially  enhances 
the  value  of  a  whole  neighborhood  and  through  its 
facilities  for  traffic  adds  to  the  general  welfare  of 
the  whole  community  will  not  be  admitted  by  objectors 

1  See  Financial  Chronicle. 


224  Investment  Bonds 

to  the  plan.  At  any  rate,  these  bonds  lacking  a  direct 
claim  for  their  safety  on  the  issuing  municipality  are 
poorly  regarded  in  the  investment  market  and  there- 
fore avoided  wherever  possible. 


CHAPTER  XXIII. 

SINKING  FUND. 

MANY  methods  of  paying  off  corporation  debts 
have  been  devised  but  of  all,  none  is  capable  of  such 
diversity  of  application  as  that  of  the  Sinking  Fund. 
Nor  has  any  claimed  such  universal  attention  as  this. 
For  nearly  two  hundred  years  economists  and  others 
have  studied  the  subject  closely  and  given  it  extensive 
treatment  in  their  writing,  so  that  to-day  the  biblio- 
graphy of  sinking  funds  is  voluminous.  Nearly  all 
this  writing,  involving  many  theories  and  recording 
the  history  and  operation  of  this  mode  of  extinguish- 
ing debts  in  Europe  and  America,  rinds  its  inspiration 
in  the  relation  of  sinking  funds  to  public  finance 
and  the  economic  effect  of  their  institution  and  main- 
tenance. Public  debt  was  first  to  engage  the  serious 
attentions  of  the  best  financial  minds  of  by-gone  years 
and  as  its  extinguishment  became  a  matter  of  growing 
importance  means  for  its  accomplishment  were  sought. 
The  sinking  fund  plan  was  largely  adopted.  For  i 
beginning  we  must  go  back  to  the  year  1716.  Eng- 
land's debt  was  "funded"  by  the  revenue  from  many 
separate  sources  being  pledged  to  redeem  some  special 
part  of  the  debt.  The  complications  that  grew  out 
of  this  led  to  a  simplification  and  from  the  surplusses 
of  three  principal  funds  established  to  take  care  of 

225 


226  Investment  Bonds 

the  interest  requirements,  was  built  a  sinking  fund 
"to  the  sinking  of  the  national  debt  and  to  no  other 
purpose. " 

Many  changes  from  the  original  method  of  applying 
a  sinking  fund  have  been  wrought  and  in  some  cases 
it  has  been  discarded  as  inefficient,  yet  it  still  exists 
as  an  important  element  in  some  phases  of  public 
finance.  With  the  development  of  private  enter- 
prise and  issuing  of  large  amounts  of  bonds  it  nat- 
urally became  a  consideration  in  this  field,  although 
it  never  attained  the  importance  here  as  in  its  relations 
to  the  public  debt.  Before  the  adequacy  of  this  means 
of  invariably  sinking  a  debt  was  brought  into  question, 
universal  adoption  was  the  rule,  but  immediately 
that  question  was  raised  and  its  shortcomings  dem- 
onstrated, it  became  less  a  factor  in  public  finance. 
Generally  speaking,  its  position  in  both  public  and 
private  finance,  especially  the  latter,  is  now  less  prom- 
inent than  in  past  years  and  the  indications  are  that 
this  method  is  growing  out  of  favor  to  some  extent. 

Of  all  corporations,  governments  are  least  com- 
mitted to  the  maintenance  of  sinking  funds;  their 
general  policy,  as  already  explained,  is  to  refund  all 
debt  in  the  greatest  measure  possible,  thus  practically 
perpetuating  it.  In  the  smaller  civil  divisions,  the 
practice  is  widespread,  a  very  large  proportion  of 
State  bonds  throughout  the  Union  carrying  with  them 
provisions  for  this  means  of  retirement  although  some 
States  have  entirely  abolished  the  practice.  Munici- 
palities, large  and  small,  of  all  types,  still  more  gen- 
erally have  sinking  funds,  few  or  many.  Like  unto 
Governments,  these  all  do  refund  many  of  their  obli- 
gations, but  the  other  method  of  providing  for  payment 
of  their  debts  is  almost  universal.  While  in  some 


Sinking  Fund  227 

instances  sinking  funds  are  demanded  by  law  of  munici- 
palities as  when  the  charter  of  a  city  compels  it,  no 
such  standing  requirement  applies  elsewhere.  They 
may  be  maintained  by  states,  but  if  mandatory  the 
provision  would  be  embodied  in  the  specific  act  author- 
izing the  issue  and  not  in  a  constitutional  enactment. 
If  the  law  were  not  a  dead  letter,  as  it  has  been  for 
almost  a  dozen  years,  the  United  States  Government 
would  be  consistently  maintaining  a  sinking  fund. 
Back  in  1868,  the  sinking  fund  first  appeared  in  our 
Treasury  accounts  and  then  to  strengthen  the  credit 
of  the  country  abroad.  Under  the  original  law  one 
per  cent,  of  the  debt  was  to  be  retired  each  year. 
Fully  explicit  as  this  is,  the  Secretaries  of  the  Treasury 
for  some  years,  nevertheless,  have  exercised  discre- 
tionary powers  in  its  observance,  consulting  rather 
the  condition  of  the  Treasury  than  the  mandate  of 
law.  In  1905,  for  instance,  something  like  $4,000,000 
of  bonds  were  purchased  for  the  sinking  fund  while 
the  amount  should  have  been  nearly  $60,0000,00. 
Altogether  the  Treasury  owes  the  sinking  fund  some- 
thing over  $500,000,000. 

Turning  to  other  types  of  corporations  we  find 
almost  entire  absence  of  sinking  funds  among  steam 
railroads.  Probably  not  more  than  fifteen  per  cent, 
of  all  such  bonds  falls  within  this  category.  Industrial 
corporation  bonds,  on  the  other  hand,  are  very  largely 
sinking  fund  issues;  it  is  safe  to  say  seventy-five  per 
cent,  of  the  total  outstanding  are  such.  There  are 
yet  other  types  of  business  that  employ  this  method 
in  their  financial  arrangements.  The  public  utilities 
bonds  quite  generally,  although  not  so  much  as  the 
last  mentioned,  are  of  this  character.  Further  than 
this  are  mining,  lumbering,  coal  companies,  and  the 


228  Investment  Bonds 

like,  who,  we  might  say  invariably,  fully  to  the  extent 
of  ninety -five  per  cent.,  maintain  sinking  funds  for 
their  bonds.  Thus  it  is  that  the  practice  varies  with 
the  class  of  corporation.  It  may  be  entirely  absent, 
partially  used,  or  the  rule  rather  than  the  exception; 
it  is  mandatory,  optional,  or  expedient,  much  according 
to  this.  Mandatory  only  with  some  public  corpora- 
tions, and  optional  with  all  others,  though  actually 
imperative  with  certain  of  those.  Note  the  funda- 
mental differences  that  account  for  this.  Railroads, 
on  the  whole,  are  properties  becoming  stronger  with 
each  decade  and  are  least  sensitive  to  the  shocks  of 
adversity.  The  advancing  values  of  their  real  estate 
and  the  enhancement  of  the  properties  through  physi- 
cal development  makes  for  a  constant  appreciation  in 
assets  and  greater  earning  power,  generally.  For 
these  reasons  the  security  of  their  bonds  becomes 
more  firm  in  the  same  ratio.  Manufacturing  and  other 
industrial  plants  with  greater  susceptibility  to  depres- 
sion and  more  rapid  depreciation  must  maintain 
sinking  funds  to  safeguard  their  bonds,  lest  by  mis- 
management or  overzealousness  to  make  dividends 
at  the  expense  of  maintenance,  bondholders  might 
find  a  property  thoroughly  " skinned"  at  the  maturity 
of  their  long-term  bonds.  With  such  concerns  as 
mining,  lumber,  or  coal  companies,  it  is  manifestly 
necessary  from  the  very  beginning  to  provide  for 
ultimate  redemption  of  the  bonds  for  other  and  more 
obvious  reasons  than  with  the  industrial  plants.  By 
digging  so  much  coal  or  cutting  so  much  lumber  just 
so  much  of  the  security  of  their  bonds  is  taken  away. 
Here  then  is  a  condition  where  the  very  assets  of 
the  business  are  disappearing  with  each  succeeding 
year.  Hence,  any  corporation  whose  assets  are 


Sinking  Fund  229 

depleted  by  the  operations  of  business  has  practically  i 
no  choice  in  the  matter ;   that  it  operate  sinking  funds 
is  imperative. 

The  amounts  constituting  sinking  funds  vary  greatly, 
being  entirely  in  conformity  with  conditions.     Except 
in  comparatively  few  instances  no  exact  sum  is  set 
down.     Where  so,  a  definite  amount  per  annum  may 
be  assigned  to  this  use  but  indefinite  amounts  are  the 
effect  of  such  provisions  as  these;   that  a  certain  per- 
centage of  gross  or  net  earnings  shall  be  set  aside; 
that  so  much  shall  be  applied  if  earned ;  that  all  surplus 
earnings  over  interest  charges  shall  be  put  to  this  use; 
that  a  fund  may  be  established  if  the  earnings  reach 
a  certain  point  or  are  in  excess  of  a  prescribed  amount. 
A  little  different  statement  of  about  the  same  thing 
occurs  where  coal  and  lumber  lands,  power  companies, 
etc.,   are  involved;    for  every  ton   mined,   for  every 
thousand   feet  of  lumber  cut,  for  every  horse  power 
of    energy    generated — so    many    cents   must    be    set 
aside.     Such  reference  to  earnings,  of  course,  is  not 
made   in    public    corporations   where   revenues   come 
generally  from  a  different  source.     A  measure  of  cal- 
culation  may   enter   there  permitting  predetermined 
amounts  which  cannot  be  tinder  such  uncertain  terms 
as  above  mentioned.     There  are,  however,  many  cases, 
among  all  kinds  of    corporations  where  the    sinking 
fund  is  made  equal  to  a  percentage  of  the  bond  issue  - 
itself — sometimes  it  is  a  graduated  percentage  vary-  , 
ing  with  the  length  of  time  the  bonds  have  to  run.     In 
municipalities,   often,   an   appropriation   of  a   certain 
amount  from  general  funds  is  applied,  or  again  the  fund 
is  annually  equivalent  to  a  percentage  of  the  assessed 
valuation. 

While   sinking   funds   of   public   corporations   may 


230  Investment  Bonds 

be  said  to  spring  from  taxation  generally,  and  those 
of  other  corporations  from  earnings,  exceptions  are 
found  in  either  case.  As  applied  to  our  Government 
and  many  State  bonds,  little  deviation  from  the  rule 
is  found ;  but  many  municipal  issues  have  their  special 
source  of  revenue  creating  a  sinking  fund.  Generally 
these  incomes  are  sufficient  in  amount  and  absolutely 
pledged  to  be  devoted  to  the  particular  bonds  as 
they  mature.  Some  funds  come  from  such  sources 
as  licenses,  railroad  franchises,  court  fees  and  fines, 
market  rent,  while  the  bonds  covering  docks,  water 
supply,  etc.,  produce  their  own  income  fully  providing 
for  their  sinking  funds  and  ultimate  retirement.  When 
sufficient  income  obtains  from  these  sources,  any 
burden  of  direct  taxation  is,  of  course,  removed.  Just 
so  is  the  necessity  of  drawing  from  earnings,  strictly 
speaking,  eliminated  where  such  bonds  as  Land  Grant 
and  Collateral  Trust  are  provided  with  sinking  funds. 
The  mortgage  for  the  former  provides  that  funds 
obtained  by  sale  of  the  land  shall  be  applied  thereto 
while  the  latter  may  be  considered  generally  as  pro- 
ducing their  own  interest  from  underlying  collateral 
above  which  all  surplus  goes  toward  a  sinking  fund 
out  of  which  the  trust  bonds  are  redeemed. 

Aside  from  illustrative  types  such  as  these,  there 
is  generally  an  alternative  in  the  application  of  a 
sinking  fund.  That  is  to  say,  no  arbitrary  application 
of  the  fund  is  demanded.  It  may  be  used  to  retire 
bonds  of  that  specific  issue  under  consideration,  or, 
if  conditions  are  unfavorable,  invested  in  other  secur- 
ities. Any  sinking  fund  operation  of  the  United 
States  would  always  be  toward  directly  retiring  the 
national  debt,  but  the  States  generally  have  more  or 
less  latitude.  Their  funds  may  be  put  into  their  own 


Sinking  Fund  231 

obligations  yet  some  may  purchase  United  States, 
city  and  town  obligations  for  this  purpose.  New 
York  State  sinking  funds  are  practically  free  to  take 
up  any  good  security  since  the  sole  requirement  is 
that  they  shall  be  "safely  invested."  Municipalities 
guided  by  charter  provisions  largely,  have  varying 
degrees  of  freedom.  They  are  restricted  to  definite 
types,  specifically  named  issues  or  again  have  only 
standardizing  requirements. 

In  some  others  than  public  corporations  what  is 
ostensibly  a  sinking  fund  may  never  become  such, 
due  to  the  stipulation  that  if  bonds  of  the  issue  itself 
cannot  be  bought  at  a  certain  price,  the  money  may 
be  applied  for  other  purposes — to  dividends  in  a  few 
instances  and  to  purchasing  equipment.  Under  sim- 
ilar circumstances,  the  trust  deeds  of  some  issues  per- 
mit investment  in  securities  legal  for  savings  banks. 
Just  here  it  is  well  to  note  an  essential  difference  in 
the  sinking  fund  operations  of  various  corporations. 
Those  of  a  public  character  never  call  their  bonds; 
that  is,  when  sinking  fund  money  is  available,  no 
drawing  by  lot  is  ever  done,  thus  compelling  their 
release  by  holders.  On  the  contrary,  private  cor- 
poration bonds  are  taken  up  in  this  manner  at  a  des- 
ignated figure,  often  to  their  detriment  in  market 
quotation.  Thus  it  is  that  when  the  money  funds 
are  turned  into  investment  as  a  sinking  fund,  they 
may  operate  in  either  of  two  ways:  one — taking  up  , 
or  retiring  a  part  of  the  actual  bonds  of  the  specific 
issue;  two — purchasing  other  securities  and  leaving  y 
the  entire  issue  outstanding,  but,  of  course,  in  this  Way 
providing  for  its  ultimate  extinction  by  realizing  on 
them  when  the  proper  time  comes.  Thus  if  a  sinking 
fund  is  invested  in  outside  securities,  it  is  calculated 


232  Investment  Bonds 

that  it  must  produce  by  maturity  sufficient  to  retire 
the  whole  issue,  and  with  the  last  payment  used  to 
purchase  or  redeem  the  actual  bonds  completely 
wipe  out  or  retire  them.  In  other  words,  one  method 
builds  up  an  amount  until  maturity  to  pay  off  the 
debt;  the  other  takes  up  the  bonds  as  it  goes  along. 
Taking  up  the  bonds  as  it  goes  along,  however, 
involves  two  considerations:  whether  the  bonds  shall 
be  held  as  alive  or  cancelled  immediately.  At  the 
present  time  bonds  are  cancelled  more  than  other- 
wise, although  the  matter  is  largely  of  negotiation 
between  the  issuing  company  and  its  bankers.  If 
the  bonds  are  absolutely  retired  when  taken  up  by 
the  sinking  fund  appropriation  the  liabilities  of  the 
company  are  thereby  reduced  in  that  amount;  when 
held  alive,  the  liabilities,  of  course,  remain  the  same 
throughout  the  whole  term  of  the  issue  and  conse- 
quently fixed  charges  represented  by  their  interest 
remain  constant  until  the  end.  Cancellation  means 
that  interest  charges  to  the  amount  involved  abso- 
lutely cease ;  holding  the  bonds  means  that  the  charges 
cease  so  far  as  the  public  is  concerned  but  in  the  ac- 
counts of  the  corporation  entries  must  be  made,  trans- 
ferring, as  it  were,  these  funds  from  one  pocket  to 
another,  where  they  are  put  to  stay.  The  desirability 
of  either  method  must  be  decided  not  so  much  from 
principle  as  from  conditions.  If  the  bankers  require 
the  securities  held  in  force,  it  is  from  their  analysis 
of  the  property  and  judgment  of  the  future.  They 
may  deem  it  a  wise  provision  to  maintain  the  fund 
which  will  absorb  the  interest  money  regularly. 

The  administration  of  the  sinking  fund  in  either 
case  is  generally  a  function  of  the  trustee.  The  trust 
company,  who  is  usually  the  trustee,  receives  the 


Sinking  Fund  233 

amount  to  appropriate  toward  the  fund,  and  it,  of 
course,  must  see  that  the  provisions  of  the  mortgage 
are  complied  with.  Occasionally  the  mortgage  pro- 
vides for  a  sinking  fund  commission,  officers  of  the 
company,  who  administer  affairs  along  the  same  lines 
as  a  trustee.  When  bonds  are  to  be  taken  up  by  the 
sinking  fund  notice  is  put  in  public  print  of  the  num- 
bers, if  drawn,  and  the  fact  that  the  interest  thereon 
will  cease  on  the  date  named,  or  to  the  effect  that 
the  trustee  has  at  its  disposal  a  specified  sum  and 
offers  to  buy  a  sufficient  amount  to  exhaust  the  said 
sum.  This  matter  of  public  notice  is  a  practical  objec- 
tion w^ith  investors  to  drawn  bonds.  Such  an  adver- 
tisement is  full  legal  notice  of  cessation  of  interest  and 
is  binding.  If,  then,  the  holder  does  not  chance  to 
see  it  immediately,  he  stands  to  lose  by  the  oversight. 
But  the  absence  of  trusteeship  in  public  corporations 
necessitates  a  different  procedure.  The  State  Treas- 
urer is  generally  the  supervising  officer  of  State  sinking 
fund  operations  while  in  municipalities  the  practice 
varies.  Small  ones,  of  course,  do  not  need  and  there- 
fore have  no  elaborate  arrangements ;  but  cities,  with 
their  large  debts,  complicated  accounts,  and  multiplied 
sinking  funds  must  needs  have  some  administrative 
body  for  this  work.  New  York  City  has  ten  sinking 
funds,  the  assets  and  accounts  of  each  being  kept 
separate  and  the  Board  of  Commissioners  is  composed 
of  the  Mayor,  Comptroller,  Chamberlain,  President  of  the 
Board  of  Aldermen,  and  the  Chairman  of  the  Finance 
Committee  of  that  Board.  In  another  city  retirement 
of  bonds  and  payment  of  interest  is  entrusted  to  a 
Sinking  Fund  Board  of  Trustees  of  four  members, 
appointees  of  the  Mayor.  This  board  fixes  the  amount 
of  tax  levy  for  the  creation  of  sinking  funds  and 


234  Investment  Bonds 

exercises  its  discretion  in  the  investment  of  funds 
and  is  given  always  first  opportunity  of  purchasing 
new  bonds  when  issued.  In  Philadelphia  the  Sinking 
Fund  Commission  is  the  Mayor,  Comptroller,  and  one 
citizen,  reporting  to  the  Council.  Yet  again  we  find 
four  appointees  of  the  Mayor,  not  more  than  two  of 
whom  shall  be  of  the  same  political  party;  and  in 
another  instance,  a  "Board  of  Liquidation  of  the 
City  Debt,"  composed  of  bankers  and  business  men 
in  the  majority  and  several  city  officials  in  the  minor- 
ity; a  constitutional  board  free  from  control  of  the 
city  authorities.  These  illustrations  are  represent- 
ative of  the  personnel  of  sinking  fund  commissions 
throughout  the  land  whose  duties  in  some  places  are 
explicitly  prescribed  and  in  others  regulated  by  the 
most  general  provisions. 

The  sinking  fund,  as  a  principle  in  public  and  pri- 
vate finance,  is  not  open  to  attack.  Theoretically 
the  method  is  conceded  to  be  sound  but  unfortunately 
for  the  theory,  practice  and  expediency  have  left 
wide  open  a  question  of  its  utility  and  the  wisdom  of 
its  establishment.  That  the  extinguishment  of  most 
public  debt  should  be  provided  for  by  application  of 
funds  at  regular  intervals  is  generally  acknowledged 
to  be  correct  procedure:  but  the  provocative  of  con- 
troversy is  the  best  method  for  its  accomplishment. 
So  the  question  in  public  finance  resolves  into  about 
this  form — is  it  the  sinking  fund  or  some  other  method 
that  is  best,  that  is,  safe  and  sure?  while  in  private 
finance  the  point  at  issue  is  whether  at  all  a  sinking 
fund  shall  be  established.  In  the  one  it  is  purely  a 
matter  of  relative  efficiency;  in  the  other  largely  a 
question  of  policy. 

Much  of  the  anti-sinking  fund  argument  in  public 


Sinking  Fund  235 

finance  has  for  its  foundation  the  fact  that  the  opera- 
tion of  such  funds  has  often  proved  a  failure  more 
from  the  manner  of  administration  than  anything 
else.  The  inviolability  of  such  funds  is  not  sacred  to 
some,  it  is  argued,  the  confirmation  of  which  is  the 
experience  of  some  municipalities  where  the  integrity 
of  an  accumulating  sinking  fund  has  been  violated 
and  it  has  been  misappropriated.  Dishonesty  or 
incompetency  of  management  are  therefore  possi- 
bilities. However,  were  it  not  for  the  fact  that  such 
a  fund  is  seldom  placed  beyond  the  control  of  the 
debtor,  as  with  a  trustee,  this  objection  would  be 
unheard.  How  great  an  element  of  weakness  this 
may  be  is,  of  course,  problematical.  Since  public  sink- 
ing funds  are  subject  to  legislation  it  is  further  argued 
that  in  this  situation  there  is  potential  danger.  It 
is  quite  possible  that  unfriendly  or  unwise  legislation  - 
regarding  the  investment  of  such  funds  could  seri- 
ously affect  the  efficiency  of  administration.  But 
both  of  these  objections  are  based  on  suppositious 
conditions.  From  a  fiscal  aspect  others  are  raised. 
One  swings  about  the  question  of  interest.  Because 
of  the  uncertainty  of  interest  rates  obtained,  the 
necessary  investment  in  securities  may  not  produce 
sufficient  to  liquidate  the  loan  at  maturity.  Or, 
again,  there  is  possibility  of  an  excess  of  the  amount 
required.  Furthermore,  a  heterogeneous  lot  of  secur- 
ities is  purchased  from  time  to  time  and  at  the  end 
of  the  period  this  accumulation  must  be  sold  to  obtain 
the  necessary  funds.  Conditions  at  that  time  may 
be  entirely  unfavorable  to  such  an  operation  and  the 
proceeds  of  such  sale  would  suffer  accordingly.  By 
some,  investment  in  the  debtors'  own  bonds  for  the 
sinking  fund  is  held  to  be  worthless  from  the  stand- 


236  Investment  Bonds 

point  of  the  creditors'  security  and  indeed  in  a  few 
instances  the  right  of  sale  by  a  city  of  its  bonds  to 
itself  for  its  sinking  funds  has  been  denied  by  the 
courts.  There  is  a  case  on  record  where  the  court 
of  a  Western  State  ruled  against  the  purchase  by  a 
municipality  of  its  own  bonds  on  the  ground  that 
it  was  "inconsistent  with  the  essential  character  of 
the  sinking  fund,  and  so  destructive  of  the  purposes 
to  be  conserved  by  its  maintenance  that  it  must  be 
held  that  the  prohibition  is  implied.  To  construe 
the  law  so  as  to  authorize  such  a  sale  would  make 
the  sinking  fund  a  debt-creating  instead  of  a  debt- 
paying  scheme.  It  would  permit  a  city  to  market  its 
bonds  to  itself,  when  the  credit  of  the  city  or  the  state 
of  the  money  market  might  be  such  that  the  bonds 
would  not  sell  outside,  which  would  be  a  diversion  of 
the  sinking  fund  to  the  prejudice  of  the  city.  It  would 
enable  one  branch  of  the  city  officers  to  play  into  the 
hands  of  another  to  create  municipal  debts." 

It  is  clearly  evident  that  the  pros  and  cons  in  dis- 
cussion of  sinking  funds  in  private  finance  are  re- 
spectively of  an  essentially  different  character.  Under 
the  assumption  that  the  property  is  of  permanent 
value  and  stable  earning  power  would  it  not  be  super- 
fluous in  most  instances  to  establish  sinking  funds? 
If  by  doing  so,  the  diversion  of  money  into  a  sinking 
fund  would  be  burdensome  and  in  any  way  tend  to 
hinder  the  development  of  the  property,  then  yes. 
That  such  a  condition  is  even  more  than  possible  may 
be  argued  from  this  standpoint — that  a  sinking  fund 
cannot  be  put  into  the  property  in  the  form  of  im- 
provements, betterments,  etc.,  but  must  necessarily 
be  invested  in  securities.  So  assigned,  the  money  earns 
much  less  than  when  put  into  the  property,  and  is  an 


Sinking  Fund  237 

obvious  mistake.  With  this  in  view  and  considering 
the  matter  from  the  stockholders'  interest  it  is,  of  course, 
desirable  to  discard  the  sinking  fund  method  and  in 
preference  rely  upon  refunding  to  take  care  of  the 
debt  at  maturity.  But  they  would  not  alone  be  the 
beneficiaries  under  such  a  policy,  though  their  ad- 
vantage lay  in  possible  larger  dividends.  Under  our 
premises,  development  of  the  property  instead  of 
maintaining  a  sinking  fund  could  not  do  otherwise 
than  eventually  strengthen  the  security  of  the  bond- 
holders. Increasing  safety  from  this  method  of  pro- 
cedure would  be  more  desirable  than  such  as  would 
be  inherent  to  the  sinking  fund.  Quoting  from  a  bond 
circular  of  a  New  York  banking  house,  on  this  point 
we  read,  "other  circumstances  being  the  same,  a  sink- 
ing fund  bond  is  to  be  preferred  for  its  security"  but, 
it  adds,  "if  a  bond  is  not  well  secured  without  the 
sinking  fund  it  is  generally  true  that  no  sinking  fund 
agreement  will  make  it  safe." 

All  considered,  the  subject  of  sinking  funds  invites 
attention  from  various  directions.  It  immediately 
opens  up  the  broad  question  as  to  their  expediency, 
(when  not  positively  necessary)  a  question  involving 
many  factors  of  financial  structure  and  market  con- 
ditions. It  may  be  approached  from  the  point  of  view 
of  the  bondholders'  security,  solely,  or  from  the 
possible  advantages  or  disadvantages  accruing  to  the 
stockholders  and  corporation  generally. 


CHAPTER  XXIV. 

SERIAL  BONDS. 

THE  increasing  adoption  of  the  serial  method  of 
retiring  bonds  warrants  for  it  some  special  consider- 
ation. Even  stronger  claim  to  special  attention  arises 
from  the  intimate  relations  of  this  method,  as  a  fiscal 
policy,  to  that  just  discussed — the  sinking  fund.  A 
broad  study  of  bonds  not  only  includes  the  develop- 
ment of  these  two  phases  but  shows  their  close  asso- 
ciation. Precedent  to  such  special  consideration, 
however,  a  certain  distinction  deserves  emphasis— 
that  between  serial  bonds  and  bonds  in  series.  It  is 
obviously  true  that  serial  bonds  are  always  bonds  in 
series,  but  bonds  in  series  are  not  always  serial  bonds, 
so  that  the  common  use  of  these  terms — in  series  and 
serially — is  intended  to  convey  the  idea  of  two  entirely 
unrelated  conditions  or  facts.  Many  bond  issues  are 
put  out  in  series;  that  is,  they  are  divided  into  suc- 
cessive parts  which  may  be  brought  into  the  market 
simultaneously,  or  as  is  most  generally  the  case,  pro- 
gressively as  circumstances  dictate  or  perhaps  the 
terms  of  the  mortgage  provide  and  the  needs  of  the 
company  require.  Brought  out  in  this  latter  manner, 
the  issuance  is  often  spread  over  five  or  ten  years 
from  the  date  of  the  instrument.  Under  these  cir- 
cumstances each  part — a  series — receives  its  distin- 

238 


Serial  Bonds  239 

guishing  mark  such  as  i,  2 ;  a,  b,  etc.  As  exemplifying 
this  type,  we  turn  to  some  of  the  large  general  mort- 
gage issues  of  railroads.  Authorized  for  amounts  far 
in  excess  of  the  needs  at  the  moment,  each  succeeding 
part  naturally  required  some  designation  for  its  iden- 
tity. Furthermore,  in  some  cases,  individual  series  of 
large  issues  represent  special  application  of  the  funds 
from  their  sale,  thus  lending  a  further  facility  to  mat- 
ters. Examining  other  types  such  as  debenture, 
income,  and  one  or  two  others,  a  large  reason  for  divid- 
ing the  issue  into  series  is  perfectly  plain.  Interest 
matters  here  almost  necessitate  this  procedure.  Such 
a  division  comes  about  largely  that  payment  may 
readily  be  made  on  part  of  the  issue  perchance  all 
series  cannot  be  favored. 

Serial  bonds  are  generically  different  since  the  term 
has  particular  reference  to  the  manner  of  retirement. 
The  series  of  an  issue  generally  have  a  common  matur- 
ity while  the  term  serial  bonds  immediately  indicates  the 
varying  maturities  of  the  parts  of  an  issue.  True,  the 
series  of  an  issue  may  be  for  progressively  shortening 
periods,  but  it  is  due  to  delayed  issuance  and  not  dif- 
ferent maturities.  Practically  its  effect  is  nil  since 
most  issues  so  carried  out  run  for  many  years  making 
the  shortest  of  the  series  yet  a  long  time  bond. 

We  have  seen  that  a  sinking  fund  may  be  so  op- 
erated as  to  retire  portions  of  a  bond  issue  at  regular 
intervals  and  by  cancellation  of  the  bonds  so  taken 
up  reduce  the  total  debt  by  just  that  amount.  This 
effect  is  the  essence  of  the  plan  of  bond  retirement  and 
payment  which  we  know  as  serial  or  partial  payment. 
So  far  as  the  end  accomplished  here  is  considered,  the 
sinking  fund  and  serial  plan  are  substantially  the 
same.  As  a  matter  of  fact,  many  times,  the  money  to 


240  Investment  Bonds 

retire  the  respective  series  under  the  latter  plan  is 
actually  called  a  sinking  fund.  But  of  course  the 
operation  of  sinking  funds  is  not  limited  in  variety, 
whereas  the  serial  method  is  simplicity  itself  and 
admits  of  little  innovation.  By  this  method  the  debt 
is  reduced  periodically  by  payments  on  account  of 
principal  thereby  reducing  each  year  the  liability  and 
the  interest  charge.  It  is  simply  a  matter  of  sinking 
the  debt  by  paying  it  piecemeal. 

Inasmuch  as  most  bond  issues  are  designed  on  dif- 
ferent principles  than  this,  it  follows  that  compar- 
atively few  (but  comparatively  only)  serial  bonds 
are  in  the  market.  Our  Government  and  the  states 
never  issue  such  obligations  but  among  municipalities 
this  mode  of  financing  public  debt  has  been  adopted 
to  a  considerable  degree.  Large  amounts  of  assess- 
ment bonds  for  various  purposes  are  serial  issues. 
Other  corporations,  however,  furnish  the  bulk  of  this 
class  of  bonds.  Industrial  institutions  of  many  kinds, 
especially  in  the  western  part  of  the  country,  are  adopt- 
ing serial  bond  issues  more  and  more,  yet,  it  must  be 
said,  gradually.  Of  these  corporations,  the  majority 
are  of  that  type  which  consumes  its  assets  by  its  op- 
erations, typified  by  lumbering  concerns.  In  the  field 
of  railroad  finance  but  one  type  of  serial  bonds  is 
found  and  that  is  equipment  obligations,  some  of  which 
are  known  only  as  Car  Trusts.  As  representative  of 
their  kind,  an  enumeration  of  the  salient  features  is  in 
order.  The  origin  of  this  form  of  security  dates  back 
to  1870  when,  to  common  knowledge,  it  was  the  pro- 
duct of  necessity.  Then  the  lines  were  financially 
weak  and  in  need  of  much  equipment,  so  the  "Car 
Trust"  was  conceived.  The  history  of  these  obliga- 
tions has  justly  developed  the  theory  that  none  but 


Serial  Bonds  241 

feeble  roads  resort  to  this  method  to  obtain  rolling 
stock  but  recent  events  have  disproved  it  measurably, 
for  some  of  the  largest  makers  of  these  bonds  are  the 
strongest  in  position,  notably  the  Pennsylvania  Rail- 
road which  has  a  number  of  car  and  equipment  trusts, 
$13,000,000  of  which  was  issued  during  the  year  1905. 
In  recent  years  the  practice  of  issuing  these  obligations 
against  new  equipment  has  rapidly  increased  until 
now  the  figures  stand  near  $125,000,000.  The  method 
is  practically  a  conditional  sale  of  equipment  to  the 
railroad.  A  certain  percentage  of  the  price  is  paid  in 
cash  (of  late  issues  about  fifteen  per  cent.)  and  the 
remainder  in  instalments  and  represented  by  a  num- 
ber of  series  of  bonds  generally  maturing  annually, 
each  issue  equalling  from  ten  to  fifteen  per  cent, 
of  the  total  amount,  thus  bringing  the  last  series  to 
payment  in  about  ten  years.  The  instrument  of 
security  for  the  equipment  and  car-trust  bonds  is 
a  lease  legally,  notwithstanding  the  fact  that  the  oper- 
ation is  virtually  a  conditional  sale.  The  reason  for 
this  is  interesting.  It  brings  to  light  the  perfect  se- 
curity that  is  sought  for  these  bonds.  In  many  States 
of  the  Union  the  validity  of  a  true  conditional  sale 
against  third  parties  or  judgment  creditors  is  ex- 
tremely vulnerable,  while  a  mortgage  is  often  im- 
practicable or  impossible  because  of  the  automatic 
"after  acquired"  clause  in  an  old  mortgage  extending 
over  property  secured  in  the  future.  Hence  the  lease 
to  the  company  of  the  new  equipment  has  been  the  . 
avenue  of  success. 

But  as  drawn  in  the  earlier  days,  even  the  lease  was 
defective.  A  true  lease  is  not  intended  to  pass  owner- 
ship, it  was  held  by  the  courts,  but  merely  to  give  use 
of  the  property  for  a  certain  length  of  time.  This 

10 


242  Investment  Bonds 

difficulty  was  therefore  surmounted  by  addition  of  a 
further  condition — after  all  instalments  of  rental  were 
paid,  one  dollar  additional  would  secure  the  title. 
This  is,  of  course,  a  true  lease  and  was  sustained.  This 
lease  is  always  made  between  the  trustee  and  railroad 
company,  title  to  the  equipment  pending  completion 
of  payments  remaining  with  the  former.  Experience 
has  proved  that  security  of  this  form  is  almost  perfect : 
all  through  the  receiverships  of  the  90*8  the  receivers 
paid  car  trusts  regularly  when  interest  on  first  mort- 
gage bonds  had  gone  by  the  board.  There  seems  never 
to  have  been  a  default  on  a  car  trust  in  the  country, 
much  of  the  strength  of  their  position  lying  in  the 
fact  that  the  equipment  is  the  railroad;  without  it, 
of  course,  the  roadbed  is  useless.  Equipment  being 
necessary  for  the  operation  of  the  railroad,  the  courts 
have  held  that  expenses  incident  to  car-trust  bonds 
or  certificates,  as  they  are  often  called,  are  prior  and 
therefore  holders  have  always  fared  well. 

In  consideration  of  serial  bonds  generally,  advan- 
tages and  disadvantages  may  be  seen  accordingly  as 
viewed  from  the  point  of  the  corporation,  banker,  or 
investor.  An  endless  controversy  wages  about  the 
superiority  of  this  method  over  the  sinking  fund  for 
use  by  municipal  corporations.  Eminent  financiers 
and  lawyers  have  written,  advancing  arguments  that 
serial  bonds  prove  a  saving  over  straight  bonds;  that 
this  method  is  more  economical  and  its  benefits  accrue 
to  the  taxpayers;  that  the  difference  in  interest  and 
in  cost  on  long-time  bonds  between  the  two  fiscal 
methods  is  very  great  where  large  amounts  are  in- 
volved; that  the  serial  method  works  automatically, 
without  any  lapse  or  loss  of  time  for  investment ;  that 
there  is  no  sinking  fund  nor  any  need  of  one ;  that  there 


Serial  Bonds  243 

can  be  no  mismanagement  or  dishonesty;  that  the 
sinking  fund  method  in  many  cases  is  a  "financial 
anachronism" — out  of  date,  unreliable,  too  costly,  and 
to  be  discarded  in  advanced  municipal  finance.  On 
the  other  hand  objections  to  the  serial  bond  method 
are  advanced;  that  they  are  not  popular;  must  gen- 
erally bear  a  high  rate  of  interest  and  sell  at  a  lower 
premium  than  long-term  bonds  issued  under  the  sink- 
ing fund  plan.  The  measure  of  application  of  these 
statements  depends  wholly  upon  the  specific  instance 
under  consideration.  So  many  elements  are  involved 
varying  with  time  and  place,  that  no  sweeping  con- 
demnation or  commendation  can  be  wisely  made. 
Each  method  has  its  merits  and  demerits;  neither  is 
wholly  bad  nor  yet  the  best  under  all  circumstances. 
All  of  these  statements  do  not  hold  true  in  all  cases 
though  many  do  in  some.  This  much  may  be  said — 
serial  bonds  have  come  and  to  stay  but  as  yet  their 
propaganda  has  not  convinced  public  authorities  to  a 
point  anywhere  near  universal  adoption. 

With  others  than  public  corporations,  a  forceful 
objection  to  serial  bonds  is  the  burden  imposed  on 
Income  Account.  The  equipment  trusts  of  railroads 
cannot  be  considered  as  funded  debt  but  are  really 
a  deferred  liability  against  this  account.  Properly 
followed  out  and  paid  out  of  income  every  year,  it  is 
just  as  much  a  direct  charge  out  of  the  revenues  as 
it  would  be  if  the  whole  sum  were  taken  out  of  one 
year's  account  and  invested  in  equipment.  The  issuing 
company  simply  pays  interest  and  borrows  the  money 
intending  to  make  it  good  out  of  current  revenues  as 
time  goes  on.  The  fact  is,  too,  that  they  carry  a  gen- 
erally higher  rate,  or,  at  any  rate,  sell  to  a  higher  ./ 
yield  than  ordinary  bonds,  a  condition,  of  course, 


244  Investment  Bonds 

contributing  to  the  investors'  gain.  Notwithstanding 
this  higher  return,  the  measure  of  unpopularity,  in  the 
broadest  interpretation  of  that  word,  ascribed  to  munic- 
ipal serials,  exists  about  these  railroad  bonds.  The 
outside  public  does  not,  as  a  rule,  participate  in  their 
purchase.  They  are  generally  taken  by  banks,  insur- 
ance companies,  and  other  investment  institutions 
who  recognize  their  advantages  for  scientific  invest- 
ment of  reserves.  The  different  maturities  are  bought 
in  much  the  same  way  that  a  dealer  in  commercial 
paper  buys  the  thirty-  and  sixty-day  paper  of  well- 
known  merchants.  An  obviously  desirable  feature 
this,  the  shorter  and  longer  maturities  for  that  class 
of  investors,  it  is  practically  the  salient  point  of  un- 
attractiveness  to  the  individual  buyer  from  whatever 
corporation  the  bonds  come.  As  to  security,  munic- 
ipal serials,  of  course,  share  with  their  companion 
issues  but  with  equipment  bonds  and  the  like  it  ap- 
proaches perfection.  The  theory  is  that  as  the  latter 
series  are  approached,  safety  increases  proportion- 
ately. There  is  the  deed  of  trust  under  which  the 
property  must  be  kept  in  proper  order  and  complete 
repair;  replacements  made  of  that  worn  out,  lost,  or  de- 
stroyed ;  full  insurance  carried  and  other  provisions  for 
protection,  so  that  depreciation  is  far  slower  than  pay- 
ment of  the  series.  But  as  we  have  seen ,  a  prime  qualifi- 
cation of  bonds  is  long  maturity,  which  immediately 
disqualifies  short  serial  issues  from  fullest  favor.  In- 
vestors, for  one  thing,  are  not  partial  to  payments  of 
commissions  incident  to  frequent  reinvesting.  Natu- 
rally, bankers  are  not  averse  to  this  aspect  of  the  matter, 
and  so  where  once  there  was  disinclination  to  handle 
this  type  of  bond  there  is  now  as  much  disposition  to 
stimulate  popular  interest  by  literature  on  the  subject. 


CHAPTER  XXV. 

BALANCE  SHEET. 

ONCE  in  a  year  the  operations  of  many  corporations 
are  brought  to  focus  in  an  annual  report,  a  compi- 
lation of  statistics  with  some  explanatory  text  showing 
the  condition  of  the  corporation  at  a  certain  date  and 
covering  the  conduct  of  business  for  the  twelvemonth 
period  preceding.  It  is  a  statement  of  affairs,  ren- 
dered by  the  directors  to  the  stockholders  and  sup- 
posed to  clearly  set  forth  the  company's  position.  A 
periodical  accounting  of  this  character  to  the  owners 
of  the  business  seems  only  natural,  yet  it  is  not  univer- 
sally done.  It  is  true  those  that  do  make  reports  far 
outnumber  the  others,  nevertheless,  industrial  con- 
cerns as  a  class  have  not  fallen  into  this  custom.  Only 
a  few  make  a  fair  report — the  others  none. 

Railroads,  every  one,  present  some  kind  of  infor- 
mation to  their  stockholders  but  manufacturing 
companies  evade  the  issue  or  refuse  absolutely.  In 
justification  for  this  course  it  is  argued  that  reports 
disclose  the  inner  secrets,  and  give  a  basis  for  com- 
petitors to  form  judgments  and  make  plans.  Plaus- 
ible as  this  reasoning  appears,  it  is  not  at  all  convincing. 
The  stockholder  has  a  right  to  know  the  condition  of 
his  corporation  and  ought  to  be  furnished  with  a  good 
report.  Railroads,  of  course,  cannot  plead  this  excuse, 

245 


246  Investment  Bonds 

hence  they  issue  annual  reports  more  or  less  compre- 
hensive. The  majority,  it  must  be  said,  are  good 
though  in  some  quarters  there  is  a  noticeable  tendency 
toward  brevity.  Particularly  is  this  the  case  with  the 
properties  largely  controlled  by  a  certain  well-known 
individual  in  the  railroad  world.  It  is  said  this  is  but 
carrying  out  a  policy  begun  years  ago  when  he  said, 
henceforth  increasingly  less  information  about  his  lines 
would  be  made  public  in  this  manner.  A  contrast  to 
this  is  furnished  in  such  reports  as  those  of  the  Southern 
Pacific  Company  and  the  Pennsylvania  Railroad.  Few 
railroad  reports,  however,  are  as  meagre  in  information 
as  those  obtainable  of  industrials. 

Whatever  the  degree  of  clearness  and  amount  of 
information  contained  in  railroad  reports,  there  is  ever 
somewhat  of  uniformity  due  largely  to  the  character 
of  the  business.  In  the  end,  of  course,  they  are  made 
up  according  to  the  best  judgment  of  the  officers.  If 
the  policy  of  uniform  accounting  throughout  the 
country  shall  ever  prevail  even  more  similarity  will 
result.  So  far  as  reports  to  the  Interstate  Commerce 
Commission  go,  they  must  be  identical,  but  to  the 
stockholders  there  is  room  for  diversity. 

Every  well-prepared  annual  report  resolves  into  three 
parts.  The  first  is  an  analysis  of  the  property  from  a 
physical  point  of  view,  presenting  for  a  railroad  every 
detail  of  trackage  embraced,  equipment  owned,  and. 
facilities  enjoyed,  together  with  complete  traffic  sta- 
tistics, freight  and  passenger.  It  is  needless  to  show 
here  what  constitutes  each  of  these  as  reports  are  easily 
procured  and  may  be  studied  with  greater  profit.  Next 
come  figures  showing  earning  abilities.  All  this  is  in- 
cluded in  the  Income  Account.  Revenues,  of  course, 
are  derived  from  many  sources  and  are  likewise  ex- 


Balance  Sheet  247 

pended  in  as  many  ways  but  the  import  of  it  all  is  to 
show  gross  amounts  from  and  for  operation,  net,  other 
and  total  income,  fixed  charges,  balance,  dividends, 
and  surplus. 

But  the  information  is  yet  insufficient  to  show  the 
standing  of  the  company.  It  may  now  appear  how 
good  or  bad  the  property  is  yet  nothing  of  its  financial 
position  has  been  disclosed.  The  Income  Account  tells 
what  happened  last  year  but  no  more.  It  is,  therefore, 
necessary  to  put  the  results  already  known  with  facts 
still  untold  and  of  it  all  make  one  complete  picture. 
This  is  accomplished  in  the  Balance  Sheet.  A  Balance 
Sheet,  it  should  be  remembered  is  not  intended  to 
show  anything  for  any  definite  period  of  time;  what 
it  seeks  to  make  clear  is  how  affairs  are  at  a  certain 
date.  Hence  it  is  made  up  of  two  columns,  Debit  and 
Credit.  On  the  Debit  side  are  the  Assets,  Capital  and  * 
Current — on  the  other  all  Liabilities,  Capital  and  Cur- 
rent. Capital  assets  are  generally  represented  by  items 
of  road  and  equipment,  Securities  owned — that  is 
stocks  and  bonds  of  railroads  and  other  corporations, 
and  also  Sinking  Funds.  Under  Capital  Liabilities 
are  found  all  bond  obligations  and  stock  outstanding. 
Current  Assets  cover  such  items  as  Cash,  Bills,  and 
Accounts  Receivable,  due  from  agents,  other  com- 
panies, etc.,  while  Current  Liabilities  show  Loans,  Bills, 
and  Accounts  Payable,  due  to  other  companies,  wages 
due,  and  other  sundry  liabilities. 

In  the  presentation  of  a  Balance  Sheet  there  must 
necessarily  be  compression  of  multitudinous  items 
into  small  space  yet  it  is  possible  to  make  it  too  con- 
densed— indeed  to  the  extent  of  obscurity.  That  there 
maybe  no  misuse  of  an  account,  all  charges  of  the  year  - 
should  be  fully  itemized  and  in  the  matter  of  Invest- 


248  Investment  Bonds 

ments,  information  should  be  so  clearly  set  forth  that 
a  judgment  as  to  the  correctness  of  their  valuation 
may  be  quickly  made.  Unfortunately  many  railroad 
reports  are  not  as  explicit  on  this  latter  point  as  could 
be  hoped  for.  In  fact  one  of  the  largest  systems  of  the 
eastern  part  of  the  country  was  severely  criticized  for 
the  faultiness  of  its  last  Balance  Sheet.  No  explan- 
ation was  given  regarding  such  items  as  "  Securities 
owned,"  "  Advances  for  leased  lines,"  and  " Loaned  and 
Bills  Receivable."  The  question  was  then  raised  how 
should  these  items  be  reported.  There  can  be  no 
reasonable  objection  to  a  condensed  sheet  of  each  im- 
portant item  but  if  it  is  to  be  condensed  to  the  last 
degree,  at  some  other  place  in  the  report  details  of 
each  account  should  be  found. 

Critical  analysis  of  the  balance  sheets  of  our  railroads 
when  fully  illumined  by  statistical  tables  and  text  is  in 
itself  a  heavy  labor.  How  much  increased  then  is 
the  difficulty  of  a  clear  understanding  when  omissions 
like  these  occur.  The  express  object  of  making  a 
balance  sheet  is  to  present  a  reliable  and  complete 
financial  statement  to  shareholders.  They  fall  short 
therefore  just  to  the  extent  that  such  vital  items  as 
mentioned  are  offered  without  explanation  or  remark. 
But  the  bondholder  or  creditor  as  well  as  the  stock- 
holder has  use  for  this  statement,  for  largely  from  its 
contents  is  the  worth  or  worthlessness  of  the  corpor- 
ation's bonds  determined.  Hence  the  wise  investor 
makes  some  investigations  on  his  own  account,  for 
though  not  highly  versed  in  bookkeeping,  he  may  yet 
discover  much  for  himself. 

The  statements  for  a  single  year,  however,  are  not 
always  sufficient  for  this  purpose.  Manipulation  of 
traffic  statements,  for  instance,  is  always  possible  and 


Balance  Sheet  249 

might  not  be  clearly  apparent.  The  balance  sheet 
standing  alone,  might  not  seem  to  evidence  an  indif- 
ference of  the  management  toward  shareholders  or 
conceal  anything,  yet  such  conditions  could  exist.  In 
other  words,  isolated  statements  are  of  comparatively 
little  consequence  to  the  investor.  It  is  only  by  ex- 
amination of  a  series  and  their  comparison  that  sub- 
stantial conclusions  may  be  arrived  at.  One  year's 
results  are  no  criterion  of  others.  Even  the  ratio 
between  figures  of  two  years  are  yet  unsafe  for  final 
judgment.  So  it  is  imperative  that  the  tables  through- 
out a  report  be  matched  for  a  number  of  years;  that 
the  income  account  be  treated  likewise,  watching  the 
fluctuations  in  each  item  or  earnings  and  that  the 
balance  sheet  be  closely  scrutinized,  compared,  and 
sifted  for  discovery  of  changed  conditions  not  men- 
tioned elsewhere.  In  a  word  the  balance  sheet  should 
be  a  reliable  and  complete  financial  statement,  but  in 
any  event  may  be  a  light  unto  the  path  of  an  investor. 
Beginning  with  its  gross  amounts  an  examination 
ramifies  into  the  smallest  detail,  comprehending  every 
phase  of  the  business. 


INDEX 


Assumed  bonds,  distinctions  to 

be  made,  126 
Assessment  of  stockholders,  208 ; 

bondholders,  209 
Assessment  bonds,  223 


B 


Banking  houses,  activities  of,  55 
Bank  note  circulation,    187 
Bids  for  bonds,  49;  deposits  on, 

47 

Bond,  legal  position  of,  6;  per- 
sonal property,    160 
Bondholder,  position  of,   8 
Bond  issue,  advisability  of,    10 
Brokers,  trades  in  bonds,  56 


Capital,  as  applied  to  bonds,  8; 
as  applied  to  notes,  8 

Capitalization,  difference  in  Eng- 
lish and  American  methods, 

9 

Car  trust,   19,  240 
Certification,     by     trust     com- 
panies, 45;  compensation  for, 
46 

Certificate  of  indebtedness,  4 
Chicago  &  Great  Western  Ry., 

no  bonded  debt,  9 
Classification,  difficulty  of,  14 
Corporations,    classification    of, 

15 

Coupon  bonds,  37 
Consols  of  England,  39,  75 
Consolidation,    by    lease,     153; 
growth    of   and   how   accom- 
plished,   154;  effected  by  re- 
organization,   208 
Convertible  bonds,  178 


Collateral  trust  bonds,  190 
Curb  market,  60 


Default,   194 

Debt  limit,  with  reference  to 
bond  issue,  69 

Denominations,  standard  for  U. 
S.,  38;  conditions  determin- 
ing, 38 

Debenture,  English  idea,  31 

Distribution,  conditions  affect- 
ing, 75;  the  wider  the  better, 

8? 

Dividends,  8;  effect  of  on  bond 
market,  86 


Earnings,  consideration  of,   121 
Educational   institutions,    bond 

holdings,   98 
Equipment,    19 
Extension  of  due  date,  138 
Exchange  of  securities,  various 

reasons  for,    175 


Fixed  charges,   102;  relation  to 

security,  122 
Flat  price,  59 
Fluctuation  in  bond  prices,  82; 

in    Government    bonds,    85 
Foreign    governments,    placing 

of  their  loans,  48 
Foreign  investment,  88 
Foreclosure,  199 
France,    nation    of    savers,    40 ; 

average  investment,  40 
Fraud  in  bond  issue,  64 


251 


252 


Index 


Georgia  Central  Ry.,  income 
bonds,  102 

Government  depositaries,    187 

Government  bonds,  denomina- 
tion of,  36;  subscription  to, 
36;  limitations  in  regard  to, 
61;  savings  banks,  holdings 
of,  94;  national  banks,  hold- 
ings of,  96;  interest  rates  on, 
108;  maturity,  134;  exemp- 
tion from  tax,  162;  repudia- 
tion of,  195 

Good  delivery  on  stock  ex- 
change, 58 

Graduated  issue,  65 

Guarantor,  value  of  his  promise, 

I3I 

Guarantee,  conditions  produc- 
ing, 125;  distinct  from  certifi- 
cation, 127;  by  governments, 
129;  nature  of,  140;  a  con- 
tract, 132. 


H 


Holdings,    by    individuals,    92 ; 
by  institutions.  92 


Investment  laws,  effects  of,  95 ; 
aid  to  investors,  124 

Interest,  distinctions  to  be  made, 
100;  sources  of,  103;  when 
paid,  104;  place  of  payment, 
104;  changes  of  rate,  105 

Income,  as  basis  for  security, 
114 

Indenture,  140 ;  supplementary, 
148;  laws  in  regard  to,  148 

Insolvency,  202 

Industrial  bonds,  basis  of  se- 
curity of,  116 


Laws,    their    effect    on    special 

issues,   86;  re  savings  banks' 

investments,   193 
Lease,  variations  of  terms,  156; 

adjustment  of,   158 
Loans,  secured  by  bonds,    186, 

189 


Losses,    by    bondholders,    205; 

by  stockholders,  205 
Locality  and  bonds  held,  99 


M 


Marks  of  Germany,  37 

Maturity,  serial  method,  139 

Market,  interpretation  of,  72; 
fictitious  and  artificial,  74 

Mortgage,  its  nature,  140;  anal- 
ysis of,  143  ;  open-end,  149 

Money  market,   80 

Municipal  debt,  219 

Municipal  bonds,  authorization 
of,  43;  method  of  sale,  49; 
limitations  in  regard  to,  62 ; 
importance  of  legality,  66; 
Western  antipathy,  78;  sav- 
ings banks'  holdings,  94; 
their  interest  rates,  107;  basis 
of  security  of,  115;  maturity, 
134;  exempt  from  tax,  163; 
repudiation  of,  195 


N 


National  banks,  sell  bonds,   56 
Names  of  bonds,  19;  what  they 

indicate,  31 
Notes,   nature  of,  4;  corporate 

issue  of,  6 


Partnership,  issue  of  bonds  by, 

Pennsylvania  Railroad,  issues 
outstanding,  147 

Politics,  effect  on  market,  86 

Protective    committees,     203 

Property,  as  basis  of  security, 
112;  classification  of,  113 

Principal,  safety  of,   in 

Preparation  of  definitive  instru- 
ment, 44 

Private  corporation  bonds,  au- 
thorization of,  44 

Public  debt,  constantly  refund- 
ed, 1 68;  figures  in  regard  to, 
216 

Public  service  bonds,  basis  of 
security,  117 

Public  works,  financing  of,  10 


Index 


253 


Q 

Quotation,  methods  of,  59 
R 

Railway  debt,  aggregate  amount 
1 2 ;  relation  to  bonds  ac- 
counted for,  12 

Rates  of  interest,  relation  to 
market,  83 

Railroad  bonds,  ready  market 
for,  79;  security  of,  118; 
many  guaranteed,  127;  ma- 
turity of,  134;  refunding  of, 
170 

Return,  what  it  involves,  133 

Redemption,    135 

Refunding,   extent  of,    166 

Repudiation,    194 

Recovery,  against  governments, 
states,  municipalities  and  oth- 
er corporations,  197 

Rentes  of  France,  37 

Registered  bonds,  40 

Records,  of  bonds  issued,  1 1 ; 
of  bonds  passing  through 
exchanges,  n 


Sale,  method  of  by  other  than 
public  corporations,  50 

Savings  banks  and  low  interest 
rates,  106 

Safety,  no 

Seller  contracts,  58 

Security,  as  affected  by  guaran- 
tee, 130 

Sentiment  in  bond  market,  77 

Serial  bonds,  in  controversy,  242 

Sinking    funds,    governmental, 


226;  in  other  corporations, 
228;  derivation,  230;  admin- 
istration of,  233 ;  in  contro- 
versy, 234 

Spanish  war  loan,  46 

Stock  exchanges,  do  but  small 
portion  of  bond  business,  56; 
explanation  of  trade  on  board, 
56 

State  bonds,  limitations  in  re- 
gard to,  6 1 ;  exempt  from  tax, 
162 

Stock  market,  relation  to  bond 
market,  81 

Stock,  nature  of,  3 ;  relative  po- 
sition of,  4 

Statistics,   12 

Surety  bonds,  their  nature,  3 

Syndicates,  51 


Taxation,  effect  on  market,  84; 

in  foreign  countries,   165 
Trust  companies,  sell  bonds,  56; 

bonds  held  by  same,  97 


U 


U.  S.  Government  bonds,  au- 
thorization of  issue,  43 ;  meth- 
od of  sale,  46;  stability  of,  79 


Validity,     precautions    of,     68- 

legal  opinion  of,  7 1 
Voting,  by  bondholders,  211 


Yield,  100 


THIS  BOOK  IS  DUE  ON  THE  LAST  DATE 
STAMPED  BELOW 


AN  INITIAL  FINE  OF  25  CENTS 

WILL  BE  ASSESSED  FOR  FAILURE  TO  RETURN 
THIS  BOOK  ON  THE  DATE  DUE.  THE  PENALTY 
WILL  INCREASE  TO  SO  CENTS  ON  THE  FOURTH 
DAY.. AND,.  7P  $t.OO  ON  THE  SEVENTH  DAY 

' 


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oc'v  strtw 

1  1975    1i^ 

Brtto^^ 

'  ,  .   ? 

C.CML    AUG     6*75 

gv^ 

Ni  L> 

U.Qpf5glflLD 

KC-V^*  tJ    L.8J 

SEP  2  9  1956 

LD  21-100m-7,'33 

YC  23630 


~ 


~ 


UNIVERSITY  OF  CALIFORNIA  LIBRARY 


